The Eurozone’s Hamiltonian Movement
June 22, 2020

The Eurozone’s Hamiltonian Movement

Arnab Das. Global Macro Strategist, EMEA, Elizabeth Gillam. Head of EU Government Relations and Public Policy and Luca Tobagi. CFA, Investment Strategist

The European Recovery Instrument is Neither a Hamiltonian Moment nor a non-Hamiltonian Muddle.

- France and Germany have proposed a €500 billion European Recovery Instrument (ERI) to be financed by EU debt issuance and taxes to be given to support recovery in Eurozone (EZ) member-states hit hard by the COVID-19 pandemic, which the European Commission proposes to top up with loans of a further €250 billion.

- Many observers have hailed the ERI as Europe’s “Hamiltonian Moment”, referring to Alexander Hamilton’s federalisation of US state debt in 1790, which established US Treasuries as the sovereign debt of the United States, just transformed from a confederation to a full-fledge federation.

- We see the ERF as a major step forward in providing EMU — Europe’s Economic and Monetary Union — with the fiscal foundation required to ensure the permanence of the euro, and as a very positive signal that the EZ will do all it can to hold together in the face of the COVID-19 downturn.

- Yet, we do not see the ERI as a full-fledged Hamiltonian moment. Even with the ERI, the EZ would still lack the key features of the real McCoy: a federal government, a federal treasury, a federal debt and a fully federalised fiscal policy to underpin union. Without these, the ERF and the Hamiltonian movement could be a one-off or conceivably even reversed: Within the EZ, national politics and national budgetary and structural economic policies would remain the main platforms of democratic accountability and economic management, to complement ECB monetary policy.

- Finally, economic and political context is everything when it comes to assessing EZ integration. This Hamiltonian movement comes right now as much in response to COVID-19 hits to EZ economies as because of two major developments in Germany:

  • One, a constitutional crisis due to German legal challenges to the jurisdiction of the European Court of Justice and the independence of the ECB; and
  • Two, sharp divergences in national COVID-19 fiscal spending plans: Germany plans fiscal support far larger than other EZ member-states, undermining EZ solidarity, and could be construed as violating state-aid rules, which are now being suspended.

- We do expect the ERI to pass after the usual EZ to and fro; to help mitigate the damage from COVID-19. We would expect it to help — but not to solve — the travails of Italy, Spain or other hard-hit EZ member-states. And, we do expect it to significantly reduce doubts about the survivability of the euro in this crisis.

- We believe these achievements will help contain damage to the EZ financial and economic system, but still expect growth to underperform other major economies on the way back up — notably the US, because potential growth is lower and because eurozone national economies are less flexible and adaptable.

- When it comes to capital markets, we expect the ERF to reduce but not to eliminate pressure on country risk spreads, reflecting the reduction in EZ disintegration risk.

- Even so, we expect the great diversity in national economic performance to continue in both cyclical recovery and in potential growth, contributing to variety and volatility in country risk premia across all EZ asset classes.

- We would expect these risk premia to be range-bound, with a significant spread to Germany (given the lack of full, Hamiltonian federalisation), but well below the excessive yields reached in the EZ crisis of 2010-12, as well as the typically higher risk spreads in EM asset classes (thanks to the signal that the EZ will not be allowed to disintegrate).

- We would not expect the euro or new corona / Eurobonds to steal a march on the dollar and US Treasuries as reserve assets, given the lack of full, irreversible federalisation and the lack of a large, deep, liquid market in a single, “Eurozonal” treasury bond.

For our more in-depth assessment click here.

Investment risks

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Important information

  • Data as at 08.06.2020, unless otherwise stated. This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.

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