Recovery Fund and more flexible ECB on capital keys reward BTPs. Spread under 200, eye to note Goldman Sachs


Another day of purchases on BTPs, with the BTP-Bund spread that has fallen today even below the threshold of 200 basis points, up to 198.63 points. Ten-year BTP rates also fell, down to minimum of the last seven weeks, and falling for the seventh consecutive session, following the announcement of the Franco-German proposal on the Recovery Fund.
update with BREAKING NEWS Karlsruhe sentence, the ECB is working on an emergency plan to continue QE without Bundesbank

A further assist came in the last hours from the ECB, in particular from the governor of the Bank of France and member of the Governing Council of the Central Bank: Francois Villeroy de Galhau.
His words fueled speculation about the announcement of new extraordinary monetary stimuli. on the occasion of the ECB meeting scheduled for next week. And they also raised the doubt that Frankfurt is willing to drop what could be considered as one of the last remaining taboos to be broken: that of the capital key.

READ Capital Key rule

BARI, ITALY – MAY 26: A man passes by Giuseppe Iurlo’s photographic studio on May 26, 2020 in Bari, Italy. Many Italian businesses have been allowed to reopen, after more than two months of a nationwide lockdown meant to curb the spread of Covid-19. (Photo by Donato Fasano / Getty Images)

Purchases on BTPs thus allowed 10-year rates to fall up to 1.53%, from a spread that has returned below the 200 point threshold for the first time since mid-April.
Also thanks to the French Villeroy who, in a speech given last night, said that the national central banks of the Eurozone should prepare to buy more bonds of a certain type than others, to ensure a smoother transmission of monetary policy.
“Some central banks should be able to buy more (bonds); others less, if this were necessary to prevent a fragmentation, market dynamics or unwanted liquidity imbalances, which could occur on the markets, “said the banker.
In an interview with CNBC, Villeroy practically urged euro area central banks not to necessarily follown meticulous way to the capital key rule, with reference to the PEPP:
“PEPP is not just about quantity. His main innovation…is its flexibility..we are not bound to purchase a fixed amount (of bonds) per month … and we are not bound to a predetermined subdivision based on asset classes or jurisdictions. We are therefore open on the volume, we are open to a program with no expiration, which is rather tied to the date on which we can talk about end of the COVID-19 crisis, (..). If we want to guarantee the maximum effectiveness of the PEPP, we must not be tied to the capital key rule “.
Interviewed by Reuters, Nick Kounis, number one of the financial markets research division at ABN Amro, interpreted Villeroy’s comments stating that the ECB is likely to be willing to deviate further from the capital key rule in purchases launched with the Pandemic QE.
The wait for the Recovery Fund also raised the BTPs.
Understanding what the actual nature of the fund will be is difficult at the moment, considering that the four frugal countries (or, as former Prime Minister Enrico Letta, tirchi defined them), or Austria, Holland, Denmark and Sweden they have already submitted their counter-proposal, which confirms the clear divisions that continue to exist within the European Union.
The expectation for the proposal on the Recovery Fund that will be presented tomorrow, Wednesday 27 May, by the European Commission chaired by Ursula von der Leyen.
On a note issued today, Goldman Sachs analysts however, they calculated that, “in our baseline scenario (and in the event that the bazooka from the Recovery Fund is actually launched), Italy and Spain would receive € 85 billion and € 65 billion respectively. In reality to their contributions to the budget (EU) – analysts point out – this means that the transfer of long-term resources would be equal 1.5% of GDP in the case of Italy and 2% of GDP in the case of Spain, with the funding that would come from the ‘core’ countries and other members of the European Union. “
“At the same time, we predict that transfers to southern Europe could be much more substantial, if we looked – and so it seems to be, at least in the Franco-German proposal – to the countries that have been hit hardest by others since coronavirus COVID-19.
Goldman Sachs believes that the European Commission will present its own proposal for an amount greater than that proposed by German Chancellor Angela Merkel and French President Emmanuel Macron, equal to 500 billion euros. But in the end, the sum will not differ much from this.
“We expect that the final version of the Recovery Fund will be close to € 500 billion, with a portion represented by loans (therefore not only by grants). Specifically, we estimate that the loans they will represent 10% of the total of the Recovery Fund, therefore 50 billion euros, involving the participation of the EIB “.
According to the US giant, the Recovery Fund will not be operational in any case “Before 2021”, if you consider the approval process, which implies the ratification of all 27 parliaments of the respective EU member countries.
In the baseline scenario, Goldman Sachs predicts that i 450 billion euros which will be paid as subsidies or grants will actually be paid out in the period between 2021 and 2023, with 300 billion in 2021.
“Let’s also consider one faster scenario, in which the grants are paid out in two years (with 400 billion euros in 2021), and a ‘slow’ scenario“In which the sum is spread over four years (only € 100 billion in 2021)”. “In the baseline scenario, Italy and France each receive € 85 billion, more than Germany (76 billion) and Spain (65 billion). In the ‘generous’ scenario, the allocation to Italy and Spain rises to 120 billion and 100 billion euros respectively “. In the latter case, the transfer of net resources would be 3.5% of GDP in the case of Italy and 5% in that of Spain.
However the point is that, according to the economists of Goldman Sachs, the contribution that the Recovery Fund will give in being able to reduce the funding gap will prove, in the end, modest.
“In order to calculate the funding gap for the 2020-2022 period – defined as a public deficit net of EU support – we combine our estimates of financing needs with the purchases of sovereign debt already announced by the ECB”, Goldman analysts specify:
“Specifically, we include both the PSPP (asset purchase program known as Quantitative easing, which currently amounts to purchases of securities for 20 billion euros per month plus the sum of 120 billion for the whole of 2020) and the PEPP (the pandemic QE of 750 billion). In considering these forecasts, it emerges that the ECB will absorb emissions from the whole area (euro) of a value that will be around 10% of GDP over the next two years. In terms of country allocation, we start from our basic assumption that the Governing Council of the ECB will be overweight on France, Italy and Spain 5 pp compared to the 2020 capital key, then making purchases based on the capital key rule in 2021 “. Goldman also consequently believes that the ECB will be more flexible towards the capital key rule.
Having said that, “despite the ECB’s purchases, the ESM funds, the SURE funds and the baseline scenario for the Recovery Fund, the eurozone’s net funding gap will still be 3% of GDP in 2020-22, with the higher needs that will characterize Italy (4% of GDP) and Spain (4% of GDP), even if, Goldman Sachs points out, “manageable with respect to the size of the relative deficits”.
However, experts see the presence of upside risks on the funding gap, which are also “very sensitive to how the ECB’s purchases will be distributed. For example, the financing needs of Italy and Spain would rise significantly if the ECB decided to conduct QE based on the capital key rule (instead of rewarding France, Spain and Italy by 5 percentage points, as it is doing today) “. But Villeroy told us today that the ECB rule, for now, will be not to adhere too much to its rules. To Karlsruhe’s delight. And of all the German hawks.

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