- It can be argued that Europe’s jointly issued stimulus package is the most significant moment for the EU since the launch of the single currency.
- The new structure adopted for this package sets a precedent that diminishes the probability of a break-up of the Euro over the long term.
- This can structurally lift the multiple of European equities.
We all recall Mario Draghi’s “whatever it takes speech” in July 2012. This put the full force of the ECB against those investors who were positioning for a break-up of the single currency. Whilst this worked, it solved that crisis through force of liquidity rather than changing the fundamental structure of the union. Over the years, many investors and commentators have argued that a monetary union without a fiscal union cannot work. Whether this argument is right or wrong, many investors perceived there to be a flaw in the structure of Europe, and domestic facing European equities have traded at a discount as a consequence.
The recovery package just announced allows for grants to be passed to weaker countries, effectively amounting to a fiscal transfer from core Europe to the periphery. The Recovery Fund will be €750bn of jointly issued debt that will be issued by the European Commission, of which €390bn will be in grants and €360bn in low interest loans. The amounts are significant, but are of secondary importance to the precedent set. Germany is using their balance sheet strength to support Italy.
Looking ahead when faced with a future crisis, bearish investors will find it harder to target weaker Euro Area countries. All countries have, to some extent, the protection of the European bloc as a whole behind them. This display of solidarity strengthens the union both politically and economically. For markets, whether this step toward fiscal union is completed or not is of less relevance. The Rubicon has been crossed.
The European commission will issue €750bn of bonds between now and 2026 via capital markets. This creates a large new pool of high quality European debt that will significantly add to the depth and attractiveness of the Euro as a global reserve currency. In recent years, the US dollar has been strengthened by its unique safe haven status. Looking ahead the Euro has the potential to emerge as a credible alternative.
With a more muscular and dynamic ECB acting in concert with this step toward integration, the Euro Area becomes more strategically attractive to global investors. We anticipate asset allocators adding to European equities in the coming months. We remain optimistic about the absolute and relative returns for the LF Lightman European Fund for the rest of this year.
ECB, Lightman, Bloomberg, July 2020
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