COVID | Monetary Policy & Inflation | Politics & Geopolitics
Of the events that COVID-19 has suspended or cancelled, the commemoration of the 75th anniversary of Victory in Europe Day was not one; the end of World War II was sacrosanct.
As Walter Steinmeier, President of Germany, gave his speech on 8 May 2020, did he think what effect his words would have on Angela Merkel?
8 May 1945. On that date the Germans really were alone… Today, 75 years later, we are forced to commemorate alone, but we are not alone! That is today’s good news. We live in a vigorous and well-established democracy, in the thirtieth year of a reunified Germany, at the heart of a peaceful and united Europe.
[…]
“Never again,” we vowed after the war. But for us Germans in particular, this “never again” means “never again alone.” And this sentence is nowhere so true as in Europe. We must keep Europe together. We must think, feel and act as Europeans.
Was this the moment, sitting 1.5 metres from the podium, when Merkel thought about her legacy for Germany and came to a decision? The great peace project was the ultimate goal of her mentor, Helmuth Kohl. He had also said, ‘Whoever shapes the future politically must draw life from historical experience but must not stop there.’
Three days before, on 5 May, the German Constitutional Court (GCC) had caused a stir in European political circles and in the debt markets with a ruling that raised a fundamental question about EU law and the legality of the ECB’s Bond purchases.
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Of the events that COVID-19 has suspended or cancelled, the commemoration of the 75th anniversary of Victory in Europe Day was not one; the end of World War II was sacrosanct.
As Walter Steinmeier, President of Germany, gave his speech on 8 May 2020, did he think what effect his words would have on Angela Merkel?
8 May 1945. On that date the Germans really were alone… Today, 75 years later, we are forced to commemorate alone, but we are not alone! That is today’s good news. We live in a vigorous and well-established democracy, in the thirtieth year of a reunified Germany, at the heart of a peaceful and united Europe.
[…]
“Never again,” we vowed after the war. But for us Germans in particular, this “never again” means “never again alone.” And this sentence is nowhere so true as in Europe. We must keep Europe together. We must think, feel and act as Europeans.
Was this the moment, sitting 1.5 metres from the podium, when Merkel thought about her legacy for Germany and came to a decision? The great peace project was the ultimate goal of her mentor, Helmuth Kohl. He had also said, ‘Whoever shapes the future politically must draw life from historical experience but must not stop there.’
Three days before, on 5 May, the German Constitutional Court (GCC) had caused a stir in European political circles and in the debt markets with a ruling that raised a fundamental question about EU law and the legality of the ECB’s Bond purchases.
Merkel’s support for a strong European Union is uppermost in her mind. She has pushed back on ‘common debt with a common guarantee’ to help corona-stricken countries, and for years now she has warned about the disincentives to budgetary discipline that such pooled liability would create. But the European government bond markets were sensing strains on EU cohesion, and credit risk spreads were rising on peripheral governments’ bonds vs Bunds. Confidence in the Euro was and is still at risk. It appears she decided to take this final phase of her reign to lead Europe in a coordinated effort to help the weakest members rebuild after COVID.
On 18 May, after apparently only three conference calls with President Macron, the Franco/ German €500bn EU Recovery Fund proposal was born. At the joint press conference, Merkel encouraged comparisons to the post-war Marshall plan and channelled the language of reconstruction and solidarity ‘to bring together all the member states’. ‘Europe’, she said, ‘will face this crisis together and we will emerge from it stronger’. She sees that it’s the chance of a lifetime to frame the next historical step towards ever closer political and economic union.
Germany’s highest court had partially rejected an ECJ ruling made in 2015 that the ECB’s public sector purchase programme (PSPP) was legal. The ECB must prove the ‘proportionality’ (the balancing of monetary policy objectives against the economic policy effects) of its bond purchases, and the court stressed their interpretation of the German Grundgesetz (its written constitution), which limits forms of debt mutualisation in the EU (either direct or indirect through the ECB). The GCC has often cited the link between democracy, fiscal autonomy and budget responsibility in past rulings.
Merkel thinks she has found a workaround, however. The Recovery Fund lays down her pre-approved foundations to a future form of fiscal autonomy that is intended to satisfy the GCC’s concerns for the EU’s legal autonomy and that protects national sovereignty.
A key detail of the Recovery Fund plan involves the European Commission issuing bonds on the capital markets and distributing the funds in the form of grants. Until now, European Commission bonds (ticker EU) have directly funded loan programmes to member states – so the change to budget grants in this case is a key discussion point. Were the EC to issue a long (say 25yr) maturity, as suggested in the media, it would be a very attractive zero interest rate at current spreads. The proposal mentions a bond borrowing horizon of ‘beyond the Multi annual Financial Framework (MFF)’, which is seven years. Perhaps the EC can build a curve with mixed shorter maturity bonds and take advantage of borrowing at negative interest rates? Why not be a frequent issuer and roll the maturing issues? The EC is rated Aaa Moodys/AA S&P, trades at an attractive pick up to Bunds, and would qualify for the ECB’s purchase programme. The plan is to incorporate the additional funding into the EU Budget for 2021-2027, which will enable all kinds of sweeteners for the eastern bloc (who are worried that their existing structural loans may be lost), and targeted assurances to satisfy the ‘frugal four’ (Austria, Holland Sweden and Denmark), who have since voiced their criticism of the new programme.
Merkel is a politician; she knows how to sell a narrative and her endorsement of this particular fund structure. She was the loudest critic of anything that looked like a debt transfer, so her support conveys a credibility that it will have the checks and balances to satisfy even the biggest doubters. The markets will also trust her judgement that her fingerprints are all over the Terms and Conditions. These bonds are not ‘Eurobonds’ or ‘Corona bonds’; they are the start of a European Programme of fiscal stimulus which everyone supports. In the long term, EU budgets can incorporate extended revenue streams for the EC such as the planned FTT or another EU-wide tax, which would fall into the category of ‘own resources’ and are already eligible to be used for debt servicing. For now, she will get her fellow heads of state to see the bigger picture: to protect the Euro and ‘think [and] feel as Europeans’. They trust her, too. Politics always involves posturing and speeches to please a domestic audience.
This plan is not a shoo-in, and she is taking a calculated risk. But it is not rash. She has re-asserted her authority, and her longest serving former cabinet minister, Ursula von der Leyen, is nicely in charge of the European Commission for a 5-year term, so her legacy will be safe. The EGB convergence trade can re-commence; now there is still some very public negotiating to get through.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)