TwentyFour Asset Management
Markets opened today to the news that German Chancellor, Angela Merkel, and French President, Emmanuel Macron, had reached an agreement to support the launch of a €500bn support package to aid the European Union’s recovery from the coronavirus outbreak, which has devastated large parts of the continent.
If it wasn’t so small and so late, and if Austrian officials hadn’t started pouring cold water on the idea before the aforementioned leaders had even hung up their phones, we might almost begin to get excited. As it stands, however, the European Commission (EC) is set to publish its own plans on May 27, which will then be discussed by EU finance ministers at their next summit, which isn’t scheduled until – checks notes – June 18 and 19.
When you consider the timeline for the spread of the virus across Europe, the lack of action to this point has been very evident. Italy banned flights from China as far back as January 31. At the end of February Janez Lenarčič, the EU’s commissioner for crisis management, bemoaned the lack of action when Italy first requested assistance. In late March the EC’s president, Ursula von der Leyen, also strongly criticised the lack of action with some choice phrases, including “when Europe really needed an all-for-one-spirit, too many initially gave an only-for-me response,” and “when Europe really needed to prove that this is not only a fair weather union, too many refused to share their umbrella”.
Since then, the EU has taken steps and announced various packages to help the fight against COVID-19. However, these pale in comparison to the actions announced by the US, where the joint response from the Federal Reserve and the government has been swift and decisive with a range of programmes launched to prop up the economy, while the UK has also been on the front foot. The difference in response was starkly emphasised when a proposal for jointly issued ‘Coronabonds’ was voted down aggressively by the Dutch government, a move that drew criticism from even its own citizens.
The lack of action is having a huge impact on the periphery of the bloc, particularly in Italy and Spain, where some major cities remain in full lockdown even as Germany’s shops have gradually been reopening since May 6.
The economic situation in Italy is particularly dire, with debt-to-GDP estimates touching 160% by 2021 and numerous research pieces pondering the question of an eventual Italian default. RBS analysts, for example, note that given Italian government bond spreads, the implied 10-year default probability is just over 30%, with a 30% recovery. Given Italian support for the EU project had already been waning, there is no doubt that when ex-Deputy Prime Minister, Matteo Salvini, appears once again, he will have plenty of new ammunition for anti-EU rhetoric, and many of the numerous unsupportive comments from Italy’s European “partners” will surely be dusted down for the next campaign trail.
In the meantime, we can only hope that the Eurozone authorities can get their act together and provide the support that is so desperately needed, with GDP set to plummet and unemployment numbers soaring. It was at least encouraging to see Merkel and Macron’s proposed joint EU borrowing would be spent to help those regions most affected by COVID-19. Certainly, the markets have reacted well to the agreement and 10-year Italian government bonds have rallied to a yield of 1.63%, from around 1.8% on Monday (still well above the -0.48% enjoyed by Germany).
However, despite the encouraging news, we would not be surprised if investors holding significant Italian risk reacted to the positive sentiment by trimming their holdings, rather than wait on EU aid that should have come weeks ago. Remember after the global financial crisis we subsequently had a euro sovereign crisis, and while we think this is less likely today, we cannot rule out another Italian flare-up as many of the pre-conditions for such an event are currently being set.