In a process requiring a unanimous vote, the so-called “Frugal Four” countries (Netherlands, Austria, Sweden and Denmark) stood up to Angela Merkel and Emmanuel Macron – who had spearheaded the idea of an EU rescue plan involving first-ever issuance of common debt. In the end, the proposed size of the package (EUR 750 billion) was upheld but the portion devoted to grants brought down from EUR 500 billion to EUR 390 billion. Details of how the European Commission will go to market have not been provided. The funds are likely to be raised gradually (some estimates point to annual debt issuance of ca. EUR 150 billion), but maturities and interest rates remain open questions. Will a premium be offered to ensure that the operation is successful? Or, in order to avoid cash outflow during the early years, will the debt instead bear a 0% coupon but be issued below par?
The less news-grabbing, but also important, outcome of the EU summit was agreement by the 27 member countries on a seven-year “regular” EU budget, totalling EUR 1.074 trillion. We should point out that this is a gross figure, before taking into account the rebates that had to be conceded to the “Frugal Four”. The lower net figure will force spending plans to be trimmed in the areas of energy transition, technology and agriculture notably.
Of course, before any funds can be deployed, both the rescue package and regular budget need to be ratified by the EU parliament, and then by each member state. This will take a number of months – and is no done deal.
These remaining obstacles did not prevent the euro from appreciating upon the news, particularly relative to the greenback which came under opposite – and even larger – pressure, as investors acknowledged the narrowing US yield advantage and ballooning budget deficit. For, however momentous the EU agreement may be, it is dwarfed by the money that the Trump administration has been “helicoptering out” and the further economic support plans currently being debated in Congress, as both parties race to win November votes. The EURUSD thus gained some 5% in July, closing the month near 1.18.
Stock markets also continue to enjoy the ride made possible by the extremely accommodative monetary and fiscal context, despite valuations that are becoming very exaggerated. History teaches us that such upmoves cannot go on forever, but also that it is impossible to predict what will trigger a reversal – and when. Holding gold as a form of protection would thus make sense from a portfolio allocation standpoint. Recognising that the yellow metal is currently very overbought, we will be looking to regain exposure upon a correction.