Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Head of Macroeconomic Research
Summary: It's clear that, in a crisis, rules don't apply. To face one of the most important economic shocks of modern history, Germany has said goodbye to "Schwarze Null", the EC has suspended budget rules and the ECB has considerably relaxed banking and financial regulations. Initially, the EU response was too slow and too little, but this week could be decisive and show the EU is more than tedious financial transactions, it is also about demonstrating solidarity with fellow European countries facing tough time.
Click here to access to Saxo’s G7 Policy Tracker. It tracks every new monetary and fiscal measures implemented to fight the coronavirus crisis in G7 countries.
The 2012 European sovereign debt crisis led to the implementation of the banking union. The 2020 coronavirus outbreak could conduct the EU to go beyond that with the launch of Eurobonds, so-called “coronabonds”, that would implies to share out risk among all EU countries. In 2012, the idea of eurobonds had already been put forward by several European countries to deal with the crisis and limit the appreciation of Southern Europe bond spreads. But this idea had been firmly rejected by Germany at that moment. Now, it appears as an inevitable policy option to help EU states finance health spending and economic rescue programs. Over the past few days, there have been calls from Spain and Italy in favor of “coronabonds” and the EC along with Germany and Netherlands have open the door to this option on the condition it is correctly structured. This morning, ECB’s Villeroy also expressed support for common EU issuance via the ESM structure.
The economic rationale: The main idea is to allow EU members to borrow at reasonable terms even in situation of emergency. For countries that can borrow at negative real rates such as France or Germany, this is business as usual. On the contrary, Italy and some other Southern European countries may find it more challenging to navigate the bond market in this period of crisis. As we can see in the chart at the bottom of the page, Italy-Germany 10-year gov bond spread has almost doubled since the COVID-19 outbreak. There are mostly two options to cope with ongoing market tensions. The first one is to resort to the ECB’s asset purchases. The sharp increase in Germany’s new debt issuance of about €350bn this year has addressed QE scarcity but, without deviation from capital key, which is not on the table at the very moment, it would mean the ECB will need to buy even more German debt than it really needs in order to buy additional Italian or Spanish bonds. This is certainly not the most efficient way to channel funds to countries in need. The second option is to favor some form of debt mutualisation. It would consist in issuing joint Eurozone bonds or “coronabonds” and distribute the new funds raised at low rates accordingly. This option is currently favored by a growing number of EU states.
Pre-conditions: A wide political support, especially from Germany and Netherlands, requires that the common EU issuance will be well-structured and avoid introducing moral hazard. We have identified at least three pre-conditions.
There are still many unanswered questions regarding whether countries in need could have illimited access to new funds, or whether a capital key rule would apply, and how much would be charged by the ESM.
The next steps: We could have an announcement as early as this week. The Eurogroup will convene via videoconference on 24 March at 18:30 CET and could discuss technical aspects of “coronabonds”, amongst other things. Only EU leaders can go ahead with this idea, so the videoconference summit scheduled on 26 March may be of crucial importance.
There is no come back: What we have learnt from previous crisis is that when rules are broken, there is no come back. The COVID-19 is a human and economic tragedy, but we need to see the bigger picture and the positive changes that may result from this troubled period. Europe is finally showing solidarity with countries in despair and distances itself from budget orthodoxy (especially in Germany) and the inefficient 3% deficit rule. Once the health crisis will be contained, it will be important to start a comprehensive discussion at the EU level on the level of public debt and make sure that the additional debt incurred for the sole purpose of fighting the coronavirus will not remain on national books. It will also be necessary to think about the opportunity of launching special Eurobonds for infrastructure investments or to finance climate change solutions.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)