• Edward Ballsdon

QnD - EU Joint Burden Sharing?

The Macron/Merkel announcement for a €500bn fund to aid countries seemed like a bold step towards collective burden sharing, something that has been vigorously rejected by the richer Northern countries to date. here are some quick thoughts with respect to impact on market prices:

  1. €500bn is the mooted size, which will be funded by the EU issuing long dated bonds (beyond the multi-year budget framework).

  2. Under its PSPP QE program, the ECB can buy up to 50% of EU issued bonds. The other 50% will find willing buyers from benchmarked bond funds.

  3. This fund is debt - the repayment will based under their "Capital Keys". Italy, for example, has a weighting of 13.8%, making it liable for ~70bn of the loan, thus increasing its 2019 debt load of €2,410bn by 3% (eurostat)

  4. The fund will be disbursed to sectors and regions, with a hint of conditionality around budgets and reforms, with a hint of a green agenda to boot.

  5. All EU governments will have to agree to the plan.

  6. Supposedly there will be more details on the 27th May.

The headline looked great. The sum, whilst not €1trn, looked ok. But the details look as if there will be grants made BUT against individual country repayments. This is a sort of "fiscal sharing", in that Germany, France, Spain and Italy will make the biggest contributions to help pay for grants, but these same countries will have to make the biggest repayments back to the EU to repay bondholders when they expire.

All in all, whilst this is fiscal sharing in the short term, rustling up funds to help countries in need this is not a permanent "fiscal transfer". That would require the debt liabilities of the Northern countries to increase and that of the poorer countries to remain the same or decrease. Indeed, it is hard to see a huge benefit to Italy's debt position from this fund, as its debt liabilities will be larger as a consequence of this operation. This makes it hard to justify the 30bp outperformance in Btps yields vs Bunds. That seems to be just a demonstration of the speculative short positioning in the market. Tellingly, European bank stocks (SX7E) have failed to break out of their 50-55 trading range, which still sits at the all time lows.