Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Last thoughts ahead of the EUCO videoconference
Christopher Dembik
Head of Macroeconomic Research
Summary: Tonight, EU leaders will discuss the latest health and economic response to the COVID-19 outbreak. We don't expect any major achievements regarding coronabonds due to the strong opposition of Austria, Germany and the Netherlands. In these countries, debt mutualisation is anathema. Most of the discussion should be about activating or not the ESM credit line. At the occasion of the videoconference, the EU could announce the creation of a permanent European Crisis Management Centre.
The EUCO videoconference will focus on four major themes:
- Limiting the spread of the virus
- Providing medical equipment, with a focus on masks and respirators
- Promoting research into a vaccine
- Discussing solutions to mitigate the socio-economic consequences
We expect a technical discussion with no final decision about the EC proposal for an European employment reinsurance that would top up national schemes.
The EU might confirm the creation of a permanent European Crisis Management Centre in order to better coordinate the EU health response in the future.
EU leaders will lengthily discuss two major stumbling blocks:
1. The ESM emergency credit line (for more details on that point, please read our report focusing on the latest Eurogroup meeting).
The Dutch finance minister has been the most vocal opponents against activating the ESM credit line as a first emergency response for member states in need. A technical aspect, that also matters a lot politically, will need to be clarified: it is still unclear whether to attach or not conditionality to ESM credit line. It will certainly be of prime importance to lift conditionality or to soften it (i.e. making sure that the credit line is only used to cope with the effect of the COVID-19 outbreak) to gain support from Italy, Spain and France. We are carefully optimistic that an agreement can be reached either tonight or at the next EUCO videconference.
2. Coronabonds (for more insights, see our latest report Coronavirus Economics: The case for coronabonds).
Inherited divisions from the past crisis seem to prevent the launch of coronabonds for the moment. The below map, courtesy of our graphic designer Julie, shows EU countries’ support to coronabonds. Germany, the Netherlands and Austria have clearly repeated over the past few days their strong opposition to this new instrument. Yesterday, France, Italy, Spain and six other euro area governments signed a letter in favor of their implementation. In a last move ahead of the EUCO videoconference scheduled tonight, the Austrian PM rejected one more time the perspective of common EU issuance. Being realistic, we don’t see much what could unlock negotiations tonight. Given that a large part of the videoconference will be probably devoted to the ESM credit line, which will already lead to tough talks, it is likely that EU leaders will barely examine the possibility of coronabonds. This issue is likely to be discussed later.
On a final note, there has been a lot of noise over the past 24 hours about tools that the ECB could use to help countries in disarray. Yesterday, the ECB said to be “broadly in favor of activating OMT if needed”. In our view, the OMT program is certainly not the most adequate instrument to deploy in the current crisis due to its lack of flexibility (i.e. the ECB can only buy government-issued bonds that mature in 1 to 3 years). Unless OMT modalities can be changed, which is far from certain, it makes much more sense to adopt a multi-tool approach including ESM purchase (or ideally coronabonds administrated by the ESM) and PEPP (the ECB’s Pandemic Emergency Purchase Program).
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