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Euro Trembles Ahead of EU Leaders Summit as Regional Recession Looms

Euro Trembles Ahead of EU Leaders Summit as Regional Recession Looms

2020-04-21 04:00:00
Dimitri Zabelin, Analyst
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Euro Outlook Bearish, Eurozone Recession, EU Leaders Summit – TALKING POINTS

  • Politically-sensitive Euro at risk of intra-regional fissure between policymakers
  • Concerns about long-term debt sustainability could amplify Euro, equity losses
  • Sovereign credit ratings from DBRS, Moody’s, Fitch, S&P could rattle markets

Euro May Crack Under Pressure as Political Fissures Grow

The politically-sensitive Euro continues to be held hostage by intra-regional negotiations over how to combat the coronavirus. While covid-19 has affected the entire region, economies with pre-existing debt issues – most notably those bordering the Mediterranean like Italy and Spain – have been hit asymmetrically. Their economically-precarious situations have made them more vulnerable than their Northern neighbors.

Consequently, the approach on how to address the virus-induced slowdown is divided along similar lines, though it should be noted that this fissure always existed – the virus merely exacerbated it. Distressed member states in the South have pushed issuing so-called “coronabonds”, a frequently-broached debt mutualizing proposal that has failed to gain a wide-spread consensus.

While Mediterranean states argue it would lower borrowing costs and strengthen European solidarity through sharing risk, the Netherlands, Germany and Finland have strongly rejected the idea. Their concern is they may be on the hook for paying for the debt of states who’s embedded economic precarity could spill over to more fiscally prudent states.

At the upcoming virtual EU leader meeting on April 23, this topic will likely be discussed again, though reaching a consensus on it is highly unlikely – and the Euro could suffer for it. While policymakers have managed to make some headway on short-term measures to combat the virus, the question over how to pay for it in the long term is unresolved.

Some of the policies they agreed upon include the “general escape clause” which allows governments to spend beyond their legally-mandated limits outlined in the Stability and Growth Pact. However, there is still no consensus on how to pay for it when the crisis-era policy exceptions are lifted and these states now have to pay the price – in the form of higher interest payments on sovereign debt – for their deficit spending frenzy.

Brussels has agreed in the short-term to allow economically-distressed member states to tap the credit lines of the crisis-era institution known as the Emergency Stability Mechanism (ESM). However, this was met with trepidation by anti-establishment politicians – most notably in Italy – who denounce the use of these instruments out of concern it would suffer the same fate as its Greek neighbor less than a decade ago.

Policymakers at the European Central Bank have warned that another eurozone debt crisis risk looms over the horizon unless a coordinated policy response is agreed upon. The Euro’s future in this regard rests on European unity, and if the fissure between traditionally-Northern Europhiles and growing Eurosceptics in the South widens, it is likely the region’s currency will fall into the precipice.

Crude Oil Prices Go Negative – What Now?

On Monday, in another record-breaking phenomenon – one among a slew in 2020 – crude oil prices traded negative. The May contract plummeted over 300 percent in a single day, ending around -$37.63. The story behind its decline is less about the specific commodity and more about the implications of what it means for a growth-anchored asset to slip into negative territory.

Crude Oil Prices – Daily Contract

Euro Trembles Ahead of EU Leaders Summit as Regional Recession Looms

Crude oil chart created using TradingView. Note: This is the May contract which expires on April 21.

Last week, the IMF warned in its Global Financial Stability Report (GFSR) and World Economic Outlook (WEO) that the global economy may be heading for the worst economic downturn since the Great Depression. Demand for crude oil heading into the coronavirus crisis was already low amid deteriorating fundamentals, with Covid-19 magnifying the commodity’s decline as the outlook for future demand wilted.

Sovereign Credit Ratings for the Week Ahead

In a virus-fatigued market, volatility in FX markets may be amplified by credit ratings on sovereign debt from Moody’s, S&P, DBRS and Fitch. Some of the states to undergo evaluation will be the Netherlands, Greece, Italy, the UK, Israel and Romania. In normal times, these credit assessments typically do not have a significant impact – but these are not normal times.

The prospect of having to pay higher interest payments and reduced access to credit markets at a time when funding is most needed could pressure assets – particularly FX – affiliated with a distressed state. Italian 10-year bond yields are already up over 100 percent from their February-lows and could continue to rise especially against the politically-fragile backdrop.

EURO TRADING RESOURCES:

--- Written by Dimitri Zabelin, Currency Analyst for DailyFX.com

To contact Dimitri, use the comments section below or @ZabelinDimitriTwitter

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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