This is an odd week in an odd year.
Something important happened in Europe this week, and very few people care (even if they should).
The key problem with the Euro since 1999 has been that it was (and is) a currency without a fiscal union. The Euro-crisis 2010-2012 showed that very clearly, and various backstop facilities were put in place to keep it together (EFSF, LTRO, ESM, OMT).
Then came the coronavirus, and the previous backstops were no longer enough. The ECB got innovative (albeit with a lag) and invented PEPP, which was a more unrestricted form of QE than before, and it ‘smelled unlimited’ (which is what the market always craves).
And just as the PEPP QE was starting, and markets were healing, the German constitutional court started to moan about ECB QE: It needing to be restricted (pushing back against even the previous, more restrictive, incarnations of QE, called PSPP/APP).
Hence, the Euro was back in crisis mode (usual spread widening). The existing backstop infrastructure was insufficient, there was insufficient political will to create more policy space, and a German legal challenge threatened to make things worse over a 3-month period.
AND THEN we had a surprise press conference by Merkel and Macron, outlining a plan to create an additional EUR500bn of EUR spending power, via EU level borrowing. If you have common bonds, is that not a fiscal union of sorts? Crazy stuff: a solution to the problem…
May 18, 2020 could turn out to be a historical day in the evolution of the Euro. So far it is just a proposal. But the proposal did come from the two biggest countries in the union (by far the biggest after Brexit).
But the news is getting amazingly little press. It was not on the front page of WSJ or Bloomberg websites early in the week, and even in the FT, it was a secondary story (odd, since they normally care a fair bit about Europe).
Perhaps it is because the coronavirus has taken over the brains of everybody, even those that are not actually infected. Perhaps it was because the press conference was only in French and German. In any case, very few people seem to care.
But it does matter. Remember the greek default/restructuring, on about EUR200bn in 2012? Did it rock the market? What about Italy’s EUR2500bn in debt. It matters whether that pile is perceived to be at risk, including for global investors (think about owners of bank stocks…)
The Merkel-Macron proposal is just a proposal. But it is a significant one. It may be a first historic step to address the lack of fiscal capacity in the EU/Eurozone. As such, it deserves a great deal of attention.
I will leave it at that. If Merkel-Macron can get the entire EU-27 on board, it will move markets significantly. A lot of people seem sleepy at this point, but they will probably wake up once the markets are really on the move.