Agilemarkets, 20/4
Mi sembra un approccio bilanciato. Un po' lungo ma vale la pena leggere.
On Thursday night, the Eurogroup delivered as much as markets dared expect (see our preview:
(Euro)group Therapy) For the main measures, size is okay: SURE=0.8% of GDP, ESM=2% of GDP. EIB=1.6% of GDP. With the second of the two backstops, the ESM, a much bigger one gets thrown in for free (OMT=unlimited). The backstops may well not be used, but that doesn’t matter: as with guarantees, they can help reduce funding costs just by being there. The EIB package = 1.6% of GDP also helps, even if it crowds out some initiatives governments would or should have taken.
Is it enough? Yes, for now: decent numbers, and the door still open on a recovery fund. The ECB was game-changing. These measures were clearly less, but just as important as their size and scope, the message they send was that Europe continues to talk, to function and to understand its shared interest. It is particularly important that negotiations will continue on a recovery fund, although there is a political risk that southern expectations remain too high here.
Markets. We are positive periphery, especially front end Spain. PSPP/PEPP, TLTRO-iii carry trades, Friday’s Eurogroup backstops and a sufficient show of political will keeps us positive. We also draw confidence from our projection that there is light at the end of the confinement tunnel. Italy in a 130bp-200bp range… we turn negative at today’s levels if market pressure forces ESM against political convenience. ESM or SURE use could be positive for Iberia, however.
The Eurogroup, resurrected in time for Easter
What did the Eurogroup decide? The low hanging fruit was all picked. Although expected, it’s worth putting the main points into context.
- SURE. The Commission’s proposal to help fund short-working schemes around Europe. Maximum capacity €100bn (0.8% of Euro Area GDP), to be funded by the Commission via bond issuance with €25bn guarantees to be raised ‘voluntarily’ by states. Lending to recipient states, at their request, would be on ‘favourable terms’, also to be determined. There is no pre-determined allocation for this money.
It seems unlikely that SURE will be drawn on in its full size. Highly orientatively, note that France’s Labour ministry estimates that if the 6 million affected workers draw on France’s for three months the total cost could rise to €20bn. Spain may currently have around 2.6m affected workers. If that rose to 3m at an average cost of €1000 per month per worker, the total cost could be around €9bn over three months.
- EIB recapitalisation. The EIB is to be provided €25bn new capital to seed a guarantee fund intended to be levered up to €200bn. Note that the EIB will not provide the leverage itself upfront. This is a scheme to provide up to €200bn for guarantees for private sector credit. This 1.6% ‘stimulus’ if it can be deployed quickly may crowd out some of what governments would have done anyway, but it will also be partly supplementary. You might expect this to support GDP by perhaps 1pp.
- ESM pandemic crisis support… and OMT The ESM will allow new ‘Pandemic Crisis Support’ ECCL line up to 2% of each country’s GDP – i.e. €240bn if all countries were to take the maximum available. The lines in principle don’t involve any conditions, other than that the money should cover only ‘corona-related’ costs. But money is fungible, so the distinction is cosmetic, and since indirect costs are allowed, as Mr Centeno points out, it should be possible for all countries to identify 2% of corona-related spending without difficulty. Note that because crisis support lines are ECCLs, countries drawing would ensure the ECB could use OMT to support their short-dated bond issuance.
- The EU budget and a path to a recovery fund. Looking further ahead, there is an intention to work on a ‘Recovery Fund’. This is significant, but it will not be imminent and, of the many existing proposals, the more ambitious look highly unlikely. Markets would prefer a stand-alone scheme with new capital from member states. But some variation of schemes to lever the EU budget via guarantee schemes, along the lines of the InvestEU or ‘Juncker’ plans, seems more likely. This links to the EU budget – the Multiannual Financial Framework (MFF) for 2021-27 is fortunately also this year’s business. MFF discussions are also likely to adjust the way it sets up net contributors and beneficiaries in light of COVID-19’s impact across regions, but this is a second order question in terms of size. Other possibilities should also be kept in mind however: a formal mutualisation of PEPP or a deal that does not involve the whole of the euro area for example.
What are the next steps? The European Council (national leaders) will meet on April 23 to agree the Eurogroup’s recommendations. Further details of all the proposals can be expected between then and now. The ESM lines may be available by May 7.
Q1. Does this make it more likely governments will spend whatever it costs?
The ECB was the game changer…There was some risk that markets would worry early on about debt sustainability and cease to fund some countries. That has been largely addressed by the ECB’s PEPP and other measures – these were the real game changers. At this stage it no longer looked likely that governments would not be allowed to raise the money needed to make good on their pledges to spend ‘whatever it costs’.
… the Eurogroup adds some security, stimulus, and political legitimacy. The headline figure for the Eurogroup’s recommendations is €500bn (4% of GDP). But that’s not spending. €500bn is a reasonable portion of most projections of 2020 budget deficits. But the SURE and ESM are backstops only. The ESM in particular is unlikely to be drawn on by core countries and it is far from clear that it will lend anything at all, given its political toxicity in Italy especially. The EIB’s €200bn is not support to governments, meanwhile, but may supplement or replace some of their funding needs, allowing them to redeploy resources elsewhere. The bottom line these measures do make it easier to for governments to meet their pledge to spend whatever it costs, but nearly all crisis spending will be made by national governments and almost all the risk they take on will stay with them.
Q2. Does this help with debt sustainability?
EIB and confidence are marginal supports to growth. Debt sustainability is all about being able to grow GDP faster than interest payments. The Eurogroup recommendation does a little on the growth side, via the EIB programme and confidence.
Backstops and diversification reassure everyone. The more markets believe others will fund you at terms you can afford, the more likely they’ll lend to you. SURE and the ESM also do a little on the interest side, by adding some extra funding diversification at good terms. Note again, however, that these are barely significant compared to the Eurosystem, whose holdings have reduced the market free-float substantially. Although these loans will have to be repaid, in principle, we believe (and we expect the market should also believe) that the ECB is highly unlikely to stop reinvesting its holdings while there is any real financial stability concern about doing so. Who you owe money and their perceived willingness to evergreen matters.
Italy’s debt/GDP, assuming crisis-shock spending of 8% of GDP and a 8% crisis-drop in GDP, and net of ECB holdings and other European programme projections
Source: NWM, ECB, Italian Treasury
Spains’s debt/GDP, assuming crisis-shock spending of 6% of GDP and a 8% crisis-drop in GDP, and net of ECB holdings and other European programme projections
Source: NWM, ECB, Spanish Treasury
Conclusion: Expectations met for now, solidarity is work in progress
Does this ‘beat expectations’? We would characterise the Eurogroup recommendations as a narrow beat. Agreement on an ESM facility could have failed and the door on future facilities could have been more firmly closed. But at the same time it is not clear that countries will use the ESM and nothing concrete was recommended to bring the recovery fund nearer.
Does it do enough to address Europe’s political need for ‘solidarity’? Early signs are that, while the agreement is now to be sold everywhere as a win, programmes that are not used are hard to point to as a success: the ESM is unlikely to be drawn, especially in Italy unless under significant market duress. The real challenge remains the ‘recovery fund’ and reconciling excessive expectations in the south with the reality that either unanimity or an ad-hoc two speed solution is required.
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