This past week, EU leaders agreed to a historic response to the COVID-19 shock. It took four days of intense negotiations, but EU leaders were able to reach an agreement on the recovery fund (NGEU: New Generation EU) and the next EU budget. This came just two months after the initial Franco-German and subsequent EC proposals.
The speed at which EU leaders were able to come to a unanimous agreement was impressive in any context, but this is especially true given the frugal five’s (Netherlands, Austria, Denmark, Sweden and recently joined Finland) initial objection. While compromises had to be made to the frugal five, the overall spirit of the agreement remains close to key points in the EC proposal.
Outside of the quick resolution, last week’s agreement is historic for the following reasons. EU transfers will now be financed by common debt issuances for the first time. Additionally, the amount of the NGEU remained at EUR750 billion and the principals of a fiscal union have been kept. Furthermore, the support provided by the NGEU is incremental to the recovery plans at the national level and pre-existing facilities at the European level. This means it will further complement the ECB’s reactive and ultra-accommodative stance and fuel positive momentum.
Beyond the monetary aspects of the NGEU, the confidence effect is also substantial. The European Union functioning after years of lackluster progress is a significant step and should support positive sentiment in the region as it lays the path down for further EU integration.
Nevertheless, key challenges remain. The lower EU budget will impact some countries and sectors more than others. All countries should be net beneficiaries of NGEU grants, but it is still unclear whether the total amount received (NGEU and EU budget) will increase for all. Additionally, there is some uncertainty around the loan portion. The agreement does not specify how loans will be taken up—are loans given after grants have been exhausted or are they linked to specific projects? If it is the latter, this could discourage borrowing especially if funds can be accessed cheaper in the markets. Finally, there are potential legal hurdles once the political agreement is made into law such as around the EU’s ability to tax especially if market funded transfers become a permanent component.
The NGEU is a clear step in the right direction, but its funds are spread out over several years with the peak expenditure coming in 2024. Overall, the NGEU is a recovery tool not a stabilization one. This means that more is still left to be done, and the ECB is not off the hook.
The single currency continues to move higher due to factors supporting the euro and weakening the USD. On the euro side, the historic rescue fund provides support through monetary support and a reduction in breakup risks. While the money part certainly helps, the ability for EU leaders to act quickly after years of lackluster progress gives a confidence boost that shouldn’t be underestimated. Euro-area economic activity grew for the first time in five months in July. On the USD side, weakness continues with the drivers of USD weakness-- ultra-dovish Fed, cyclical currencies that tend to outperform in a global reflation environment and greater US political and economic risks (infections)—remaining. Expect further support for the euro although month end is likely to see USD buying.
The GBP has been pulled higher by the EUR as the GBP benefits from positive global growth factors. Countering this, headlines out of the UK indicates that the UK government is operating on a no-deal base assumption. The most recent round of talks have not yielded any results and the can continues to be kicked down the road. Recent retail sales and PMI numbers have been positive, but their correlation to GDP has dropped. While USD weakness/optimism around re-opening could support the GBP, Brexit developments should cap these gains.
USDJPY sits near the bottom end of its trading range over the past two months. Risk sentiment in the markets have soured with US-China tensions and virus infection numbers and global equities under pressure. Given this, expect the yen to remain in a tug of war between rising COVID/geopolitical tensions and positive economic news/positive vaccine news with a bias for USDJPY lower.
The CAD strengthened against the USD this past week, but notably, it continues to lag its G10 peers which represents the CAD’s unique vulnerability to COVID-19 shocks. Despite all of the various negatives (rising US infections, signs the initial rebound is moderating, US-China tensions), the markets remain focused on a glass half full view which implies further USD weakness. Expect range trading with a bias for strength, although should risk turn, the CAD remains more vulnerable than other currencies.
US-China tension ticked up this past week which drove USDCNY higher, but overall, the currency remains in a tight range. Ultimately, the markets are viewing the recent actions/rhetoric from both sides as largely symbolic. US-China tensions should remain elevated as we move closer to the US elections as a “tough on China” view remains supported across the political spectrum. This flags risks over the medium term but for now, continue to expect further CNY stability.
The story remains broadly the same. The correlation between the AUD and risk markets continue to hold with the AUD moving to its highest level since mid-2019. Market optimism, which some have described as relentless, received a boost from the EU Rescue Fund. Given this, headwinds are starting to build and global economies are transitioning from “easy” growth to a more difficult path as the initial re-opening bounce has passed. The AUD likely remains supported, but it’s difficult to get too excited about a move higher given the AUD’s elevated level and rising infection numbers domestically.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain at 0.25%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Consumer Confidence
Expectations for a 94.5 print
US Q2 GDP QoQ
Expectations for a -35.0% decrease
US Initial Jobless Claims
Expectations for a 1.4 million print
Canadian May GDP MoM
Expectations for a 3.5% increase
EZ Unemployment Rate
Expectations for a 0.3% increase to 7.7%
EZ Q2 GDP QoQ
Expectations for a -12.0% decrease
German IFO Business Climate, Expectations and Current Assessment Survey
Expectations for a 89.3, 96.6 and 85.0 print, respectively
German Q2 GDP QoQ
Expectations for a -9.0% decline
Asia/Japan, and New Zealand
Chinese Manufacturing and Non-manufacturing PMI
Expectations for a 50.8 and 54.5 print, respectively
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