- The agreement reached among EU leaders at the end of the longest European Council in history regarding a comprehensive package worth €1,824bn – including the Multiannual Financial Framework (MFF) and the Next Generation EU (NGEU) instrument – is a significant achievement and a net positive in the short term for EU assets.
- The Recovery Fund will increase the resilience of the EU, but it will not stabilise activity in the next 12 months. Indeed, this Recovery Fund will not be operational before the first quarter of 2021. The economic impact will not be felt until 2022. Cyclical stabilisation policies therefore remain the responsibility of the Member States.
- However, the agreement on the budget is a significant step forward and a game-changer for the EU. For the first time, the EU will mobilise the budget in a counter-cyclical manner. Fiscal policy thus becomes a stabilisation instrument in the event of a crisis.
- We see this Recovery Fund as a permanent tool to promote real convergence among EU countries. The loans will enable the fragile countries (those hardest hit) to take on long-term debt at rates they would not obtain on their own, thanks to the European Commission's triple-A rating. For the first time, the European Commission will issue debt on behalf of the EU with the objective of convergence and redistribution between countries. It's not a zero-sum game. The borrowed sums will have to be repaid, but not before 2028 (and by 2058). This means that all EU countries (including net contributors) will benefit from this massive borrowing in the coming years.
- The new debt issued by the Commission on behalf of member states should consolidate the international reserve status of the euro at a time when the role of the US dollar could be called into question due to the drift in public finances. Moreover, this will also be relevant for fixed income investors, as in a world "short of safe assets", it will provide a large and liquid highly rated asset to meet investor demand. We believe that the issuance of a large volume of common debt should encourage foreign investors to consider the EU as a whole and not as the puzzle of single issuers.
- Regarding equity, the approval of the Recovery Fund was one of the five pillars calling for a re-pricing of EU equities in absolute and relative terms. We still see upside potential from current levels, especially if – as we believe – the cyclical recovery will continue. While European equities overall are likely to benefit, we believe this is particularly positive for financials as well as peripheral countries.
- Regarding EU fixed income, credit markets probably have more room to compress further – as they have not reached the historical low yet. But, the overall environment could become more difficult going forward, with more idiosyncratic events occurring down the road. Sovereign peripherals look likely to benefit from the Recovery Fund, though they now are quite expensive. Today’s market reaction suggests that markets were expecting a positive outcome. To dig down further, sovereign spreads will need more fuel and, clearly, this will depend on the pace of the recovery and the capability of the peripheral countries to fully benefit from it – in particular, Italy.
- The significant allocation of resources for climate change/environmental projects should help boost ESG-related investments in both fixed income, with the green bond market growing in assets and diversification, and equities.
Global Investment Views - August 2022