European Markets Look to Watershed Moment on Recovery Funds

(Bloomberg) -- European investors are getting ready for a crucial milestone in the integration of the region as governments look set to agree on a stimulus plan.

Strategists called for further gains in the euro and Italian bonds after officials said countries including the Netherlands were satisfied with the level of grants proposed as part of the European Union’s recovery fund.

The common currency eased off a surge that took it to its highest level in four months after leaders pushed back the resumption of talks on Monday by one hour. Still, Spanish Prime Minister Pedro Sanchez said he hoped a compromise could be reached in the next few hours.

While the latest terms signal a watering down from initial ambitions, an agreement would mark a key moment for the bloc as it would likely lead to shared borrowing. Joint issuance would help take the strain off national debt-loads for nations such as Italy and Greece, which saw their bonds lead a regional rally.

Italy’s 10-year yield spread over Germany -- a key gauge of risk in the region -- fell to its narrowest since March. NatWest Markets sees the gap diminishing by another 15 basis points.

“A deal on the EU recovery fund should foster fiscal solidarity in Europe and create a massive new pool of high-quality, euro-denominated bonds,” said Valentin Marinov, a strategist at Credit Agricole SA in London.

The bloc’s 27 leaders will gather again at 5 p.m. in Brussels to try and settle outstanding issues such as the overall size of the fund and the mechanisms for controlling its spending.

The latest proposal for 390 billion euros ($450 billion) of the fund being made available as grants and the rest as low-interest loans has satisfied the holdouts -- the Netherlands, Austria, Denmark and Sweden, according to officials who asked not to be named.

“It is not so much the degree of financial support which is key in determining investors’ response to the recovery fund but rather whether a consensus can be achieved in terms of crossing the Rubicon of liability sharing,” said Rabobank International strategists led by Richard McGuire. “There appears to be the political will to cross the hitherto unbreachable line of liability pooling.”

The euro was up 0.1% at $1.1438 by 3:48 p.m. in London. European stocks mostly posted gains, with the Euro Stoxx 600 Index up 0.8%.

The euro’s moves sent a plethora of bullish signals on technical charts, which history suggests are strong enough for the currency to rise above $1.20 in coming months. That’s a level Deutsche Bank AG is targeting too.

Muted Rally

The moves so far were relatively muted as investors have been betting on an eventual deal, with the euro and Italian bonds both heading for their third monthly gain. Yet expectations were low for agreement over the weekend after officials played down the chances.

A deal is seen as crucial in keeping the borrowing costs of peripheral nations in Europe closer to Germany’s in the long-term. In recent months the market has been propped up by asset purchases from the European Central Bank.

“We should be more confident about recovery, and less concerned about fragilities being exposed,” wrote Giles Gale, a rate strategist at NatWest Markets, in a note. “All that would be good news for periphery spreads.”

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