Taboos Falling

After some 72 hours of needlessly fraught negotiations aimed at sealing a deal to launch Europe’s historic recovery fund, the Netherlands, Austria, Denmark, and Sweden are apparently “satisfied”.

Three long days of badgering spearheaded by Dutch Prime Minister Mark Rutte reportedly resulted in a compromise around the structure of the fund. €390 billion will be disbursed as grants, down from the €500 billion the European Commission originally proposed. The rest will be doled out as cheap loans, sources said Monday.

“It didn’t look good at a couple of moments but taking everything together, I believe progress has been made”, Rutte remarked, after putting everyone through the proverbial wringer. “We are willing to make the shift from loans to subsidies if reforms are taking place and if these reforms can be enforced”.

Apparently, the math behind Rutte’s parliamentary calculus means he needed to secure the “best” deal possible, where “best” means he was compelled to demonstrate enough in the way of obstinance to say he drove a hard bargain.

Failure wasn’t really an option. Rather, it was just a matter of timing, and almost everyone involved understood that securing a deal now was paramount. Italian spreads have come in sharply since the March panic thanks in no small part to Christine Lagarde, who vowed the ECB would not allow the crisis to result in fragmentation.

She has repeatedly called on fiscal policy to take the baton or, at the least, help shoulder some of the burden. “Our assumption is that the Recovery and Resilience Facility will come about and will be a strong mixture of grants on the one hand, in larger proportion than loans”, Lagarde said after the July ECB meeting. “My sense is that a very large number of leaders are perfectly aware of the importance of not wasting time”.

BTP-bund spreads are now the narrowest since prior to Italy’s lockdown. The ECB has deviated from the capital key with its pandemic purchase program in favor of Italy, which would receive tens of billions in grants under the recovery fund.

The yield differential pillar for the dollar versus the euro has fallen away, potentially giving the common currency scope to rally further, but stretched positioning and the notion that an agreement on the recovery fund is already baked in have many suggesting it’ll be a hard climb.

“CFTC speculative net long positioning looks stretched, holding near May 2018 highs and the common currency is increasingly vulnerable to risk appetite with its 3-month correlation to the S&P 500 rising since early June”, Bloomberg’s Laura Cooper wrote Monday. “The latter sets up for swings with headline risks in the U.S. this week around the looming fiscal cliff and virus developments”.

European equities have outperformed handily since Angela Merkel and Emmanuel Macron unveiled the proposal in May.

“Overall, if the €390 billion figure, together with a possibly reduced EU pluri-annual budget, is agreed, this will amount to a much less ambitious deal than the Commission proposal”, SocGen’s Yvan Mamalet said Monday.

“But, beside the amount of money in the Recovery Fund, to our mind, the signaling effect is key”, he went on to write, underscoring the crux of the issue. This deal, even if watered down on some key points, sets the table for a fiscal union, and in that regard marks a giant stride forward.

“If there is a deal, for the first time, after long and arduous negotiation, all the EU countries would have accepted the idea of grants or fiscal transfers, which could be seen as a first step towards fiscal integration”, Mamalet went on to say. “Another Rubicon crossed, as joint bond issuance and fiscal transfers (on a large scale) are no longer taboos”.