The EU agrees a recovery fund: a game-changing event

July 28 2020

Giovanni ZanniChief Euro area Economist

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Giles GaleHead of European Rates Strategy

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Other insights

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3 minute read

Our market specialists give their take on the recent Summit outcomes & outline what it means for you.

The European Union has finally thrashed out a deal on a huge post-coronavirus recovery package for its member states that have been hardest-hit by the virus. This represents a major achievement, and is likely to have long-lasting  implications for the European project. Let’s take a look at what the deal involves and what it might mean for investors.

After four days of negotiations, European leaders have finally agreed on a deal on a recovery fund to counter the impact of coronavirus. Its most important details are as follows.

  • Total size of fund: EUR 750bn
  • Of this amount, grants are worth EUR 390bn (lower than the EUR 500bn that had initially been proposed by the European Commission), while loans are worth EUR 360bn (EUR 250bn had been proposed)
  • The European Commission can borrow up to EUR 750bn of funds on the capital markets (in 2018 prices), but the fund is only to be temporary: net borrowing activity will stop by the end of 2026
  • The debt must be paid off by 2058

The minor tweaks that have been made to the deal are largely to the euro zone’s periphery's advantage. While the total amount of grants is down from EUR 500bn in the Commission's proposal to EUR 390bn in the final deal, the estimated amount of grants that Spain and Italy will receive has fallen only very slightly. In fact, despite the total amount of grants falling by over 20%, the grant Italy should receive is less than EUR 0.5bn lower than the amount that was initially proposed.

Grants and loans: Italy and Spain see hardly any adjustment to their grant allocation

Source: NWM, national press reports based on leaders / finance ministers declarations

Reduced political risk in Italy

The recovery fund deal is clearly good news for Italy – it’s set to receive almost 30% of the EUR 750bn – and this means the prevailing Eurosceptic attitude in Italy is likely to be much diminished. That’s good news for the European project.

Italian and Spanish spreads could tighten

The recovery fund is a game changer that has clearly reduced tail risks for Europe and the euro zone periphery in particular. Many investors are likely to be considering increasing their exposure to sovereign carry trades over the summer in response.

The EU is set to become a major force in the euro zone bond markets

As we’ve pointed out previously, the recovery fund will dramatically change the nature of European issuance, with the emergence of a large-sovereign-sized supranational issuer in the bond markets.

EU issuance has, to date, been a bit of a niche affair, funding such schemes as the European Financial Stabilisation Mechanism – hardly tiny, but rarely discussed.  As an appetiser to get the markets used to its presence, the EU will soon (from late September, in all likelihood) be selling EUR 10bn per month or so of bonds to fund SURE, a scheme to mitigate unemployment risks. The recovery fund will take over after that, probably issuing over EUR 200bn by 2023.

Potential for asset swap spreads to widen

Funding is going to be provided over a 3–30-year horizon, whereas repayments will take place over 7–37 years – a clear mismatch. Governments may look to fully benefit from low rates today by locking in rates as the funding costs will be passed through to them. This means that asset swap spreads have the potential to widen.

Regional focus: Europe

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