In the summer of 2012, it took Mario Draghi three words to alter the course of the eurozone debt crisis. Eight years later, a breakthrough from EU political leaders battling the Covid-19 threat took months of haggling, culminating in a marathon five-day summit that ended this week.
Despite the differing timescales, investors are already comparing Tuesday morning’s deal to establish a EU-wide €750bn recovery fund — from money raised in the bond markets — to the former European Central Bank chief’s pledge to do “whatever it takes” to preserve the euro.
Markets delivered an immediate seal of approval, with the single currency surging to a near two-year high against the dollar after EU leaders closed in on an agreement.
Italian government bonds, a barometer of fears about the eurozone’s health since the previous crisis, also felt the benefit, pulling Rome’s 10-year borrowing cost to the lowest since before the pandemic at less than 1 per cent on Thursday. But investors say the effects will last for years.
“After ‘whatever it takes’, this is the second big step towards fixing the flaws in the euro project,” said Luca Paolini, chief strategist at Pictet Asset Management. “By comparison everything else just looks like a sticking plaster.”
The key for investors is that the deal addresses a taboo of the EU: the notion that its members should pool their risk by borrowing jointly in bond markets, rather than going it alone.
This matter was at the heart of the debt crisis that erupted a decade ago, as investors abandoned Greece, Portugal and Ireland on the basis that their debts had become unsustainable, and threatened to do the same to Italy and Spain.
Then, Mr Draghi’s pledge to buy bonds of fragile countries calmed the storm, but the idea of member states effectively being on the hook for each other’s debts remained anathema to the fiscally conservative nations of northern Europe.
By allowing the EU to borrow unprecedented amounts using its triple A rating, countries like Italy will now have access to cheaper financing, taking the pressure off their own bonds.
“This is a pretty monumental event,” said Jim Caron, a senior portfolio manager at Morgan Stanley Investment Management. “It’s the first step down the road of burden sharing and fiscal unity.”
Investors also sense an outbreak of solidarity in the eurozone that was lacking during the previous crisis, as even “frugal” objectors like the Netherlands bowed this time to the pressure for joint borrowing.
While the fund is likely to have a limited impact on the region’s economic recovery, because of the relatively small size of the package compared with the EU’s overall output, the move marks a positive step towards ending a “nearly decade-long sovereign struggle,” according to Mark McCormick, global head of currency strategy at TD Securities.
Rating agencies also welcomed the package, which will provide €390bn in grants — less than the €500bn originally envisaged — and €360bn in loans to the countries worst affected by the Covid crisis.
S&P hailed a “breakthrough” for the creditworthiness of EU member states, while Fitch, which piled the pressure on Italian bonds with a rating downgrade in April, said the fund was “net supportive” for credit ratings and could become a permanent feature of the EU’s institutional set-up.
Many investors see in the upcoming flood of issuance by the EU itself the basis for a shared safe asset for the eurozone, potentially supplanting the German Bund as the region’s financial market benchmark. A unified debt market would allow investors to focus on the relatively strong economic fundamentals of the whole euro area, which has a small budget deficit compared to the US, according to Mr Caron.
“If you think of a United States of Europe, the financial economics look better than the US,” he said. “In theory it trades as a higher credit — that’s one reason the euro is strengthening right now and we think that’s going to continue.”
While positive, the market reaction has so far been muted compared to the impact of Mr Draghi’s pledge in 2012, which sent the euro soaring and bonds racing higher. One reason is that the ECB under current head Christine Lagarde had already stamped out a fire raging in the bond market with its €1.35tn emergency bond-buying programme, leaving Italian debt relatively little room to rally.
“Markets will now focus on how this money is used, and what impact that has on long-term growth,” said Andrea Iannelli, investment director at Fidelity International. “The disbursement of funds happens gradually so it will naturally take some time to come through.”
Friday’s stock market sell-off, fuelled by rising tensions between the US and China, is a reminder that European stocks remain as vulnerable as ever to global forces.
But one of foreign investors’ biggest objections to piling into Europe’s stock market — that Germany’s aversion to fiscal spending was squashing demand and further unbalancing the region’s economy — has been blown out of the water, Mr Paolini thinks.
“Before it was always, ‘as long as the Germans are obsessed with fiscal discipline, forget it’,” he said. “Now, Europe is back on the radar screen.”