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EU COVID Recovery Fund Approved Despite Growing Fault Lines

Forex Tips by Forex Tips
July 23, 2020
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EU COVID Recovery Fund Approved Despite Growing Fault Lines
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HYCMby Giles Coghlan, Chief Currency Analyst at HYCM

In the early hours of Tuesday, July 20, EU leaders finally agreed on a €1.82 trillion budget and €750 billion COVID recovery fund to help the economic bloc’s most beleaguered nations deal with the economic impact of the coronavirus pandemic. The agreement, set in motion by Chancellor Angela Merkel and Emmanuel Macron, will see some unprecedented actions taking place, among them is the selling of collective European bonds (rather than bonds issued by individual countries). Additionally, much of the money raised is to be handed out to EU nations that have been severely affected by the pandemic as grants, rather than as loans. To be precise, €390 billion has been set aside for grants and €360 billion for loans. Originally, the proposal was to have €500 billion earmarked for grants and only €250 billion for loans.

The New “Frugal 4-5”

One of the interesting shifts taking place within the EU is that Germany, traditionally one of the “frugal four,” has been championing the cause of Europe’s poorer southern countries rather than the interests of the wealthier northern nations it ordinarily supports. Taking into account Britain’s exit, it would seem that the dynamic is shifting with Holland, Austria, Sweden, Denmark and Finland stepping in to fill this more conservative role.

Indeed, it has been reported that the negotiations were at times strained and acrimonious, with pointed jabs and walkouts. The agreement comes amidst a great deal of concern surrounding the future viability of the bloc, particularly in the face of Brexit, the on-going effects of the Great Financial Crisis and Europe’s various sovereign debt crises; as well as the now serious economic downturn that many see on the horizon due to the coronavirus pandemic.

Markets Respond

So far, markets have responded positively to the news. The euro moved up against the US dollar to test the yearly highs it set back in early March, setting its highest daily close since the flight to US dollars earlier this year. The DAX also responded positively, gapping-up upon its open on Tuesday to trade in the no man’s land between its significant gap down on February 24. It has now recouped most of the coronavirus-related losses and is currently trading within 4% of its all-time highs. The Eurostoxx 50 also gapped-up on Wednesday, breaking above June’s highs and the levels preceding the second sell-off of March 5th. It still has some way to go to reclaim its former highs, currently trading around 11% below them.

Dax

Tensions Run High

It remains to be seen whether the summit, the second longest-running one in the EU’s history, will prove to be a historic event for Europe. Xavier Bettel, Luxembourg’s Prime Minister, was reported as saying that he had never previously witnessed positions among the 27 leaders that were as diametrically opposed as the ones expressed during the summit. Emmanuel Macron was reported to have thumped the table at one point in the negotiations, accusing those among the “frugals” who were against his proposal of being as intransigent as the British in their budget negotiations.

One of the major sticking points was the idea of making so much of the money raised by collective bond sales available as grants rather than loans. Dutch Prime Minister Mark Rutte, who has earned himself the nickname “Mr. No,” offered the most vehement opposition to the proposal.

Another sticking point was the easing of rule-of-law and green requirements that would make it difficult for nations like Hungary and Poland to access the funds. Both Hungary and Poland have come to the attention of the European Court of Justice for illiberal actions by their respective judiciaries, lack of media freedom and their treatment of asylum seekers. Poland, which is Europe’s most coal-reliant nation, would also see a requirement that it achieve carbon neutrality by 2050 dropped in order to benefit from the recovery fund. A notable compromise that went the other way involved significant increases in the rebates paid to the frugal nations who make outsized contributions to the EU budget.

One Agreement, Two Stories

On the surface, the agreement is being billed as a great success for European unity with Emmanuel Macron referring to it as a “historic day for Europe”, and Austrian Prime Minister Sebastian Kurs, one of the leaders pushing back against the proposal, tweeting that the agreement was “a good result for Europe.”

On the one hand, we have another possible “whatever it takes” moment for the EU, but on the other, it would seem that deeper fault lines are appearing within the bloc, which has had to fend off one crisis after another in recent years. The move to borrow money and make it available to troubled member states as grants, is certainly historic and represents a Rubicon European leaders have thus far been incredibly reluctant to cross. Angela Merkel was quoted as saying that “exceptional situations also require exceptional efforts.” It remains to be seen how the agreement will be put into practice, particularly since it includes a provision that would allow any single EU leader to stop the payment of funds to any member state that falls foul of the internal reforms it is supposed to be implementing.

Sell the News Event?

As mentioned above, there’s more than one way to read this story. Europe has certainly achieved a lot over the past few months, managing to contain the pandemic despite being a loose collection of nations, each with its own rules and methods of addressing it. It has also managed to achieve a provisional consensus on how to collectively combat the economic fallout, having introduced measures that many would have been unable to believe possible just several months ago. The question remains whether the underlying divisions that this recent summit has revealed – which now run east to west as well as north to south – will prove too deep to bridge in the long run.

EURUSD

The euro now finds itself at the top of its range against the US dollar, making any bets on its continued rise far riskier than they were even a month ago. The technical outlook would appear bullish, with a cup and handle pattern that goes all the way back to March, having recently broken bullish and now testing those former highs. A break of those highs would be very bullish for the single currency; however, a sell-the-news price dynamic could exert itself before then.

Trade with HYCM

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References:

https://seekingalpha.com/news/3592465-breakthrough-in-eu-coronavirus-stimulus-talks

https://www.nytimes.com/2020/07/20/world/europe/eu-stimulus-coronavirus.html

https://www.theguardian.com/world/2020/jul/20/macron-seeks-end-acrimony-eu-summit-enters-fourth-day

https://www.euronews.com/2020/07/21/eu-summit-deadlock-see-talks-stretch-into-sunday

https://www.aljazeera.com/ajimpact/impossible-eu-leaders-split-850bn-stimulus-fund-200720023337212.html

https://www.actionforex.com/contributors/fundamental-analysis/312508-stocks-rally-on-eu-stimulas/





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