Euphoric European Markets Look to Leaders to Strike a Deal

As European Union leaders try to thrash out a deal for a 750 billion-euro ($854 billion) recovery fund over the next two and a bit days, the market rally will hang in the balance.

European stocks and bonds are benefiting from renewed investor popularity, largely on hopes that the bloc will seal a historic accord to underpin the economic recovery and bind the 27 nations more closely together.

The Stoxx Europe 600 Index has advanced about 9%, while the euro-area focused Euro Stoxx 50 benchmark is up 16% since the French-German agreement on the economic stimulus proposal was made public on May 18. The plan has been cited as one of the main reasons for the preference for European equities over U.S. or global shares by investors, as well as strategists at Barclays Plc, Morgan Stanley and Goldman Sachs Group Inc.

The spread between Italian and German benchmark bond yields -- a measure of risk in Europe -- narrowed about 50 basis points over the same period.

The men and women who have to negotiate the deal though have been playing down the chances of an agreement ahead of the talks. Dutch Prime Minister Mark Rutte, a leading critic of the plan on the table, put the chances of a deal this weekend at less than 50% while Germany’s Angela Merkel and French President Emmanuel Macron, who helped trigger the rally with their May proposal, have been talking about a deal by the end of the month rather than the start of next week.

“The differences remain very, very great, so I can’t predict whether we’ll reach an agreement here,” Merkel said as she arrived at the summit venue in Brussels. “It will require a great deal of readiness to compromise from all sides so that we achieve something that is good for Europe.”

European equities declined on Friday after opening higher, with the benchmark Stoxx Europe 600 Index falling 0.3% after the chancellor’s cautious comments.

Euphoric European Markets Look to Leaders to Strike a Deal

Fund managers are getting upbeat, with allocations to euro-area stocks jumping nine percentage points to a net 16% overweight, according to the Bank of America Corp.’s July Fund Manager Survey. The EU is now the most-favored region, because surveyed investors “bought Europe on fiscal stimulus,” wrote strategist Michael Hartnett last week.

Euphoric European Markets Look to Leaders to Strike a Deal

Since mid-May, the European rally has been driven mostly by economically sensitive shares, such as technology, financials, chemicals and industrials, amid hopes that increased government spending would benefit those sectors.

“Given the recent outperformance of European cyclicals, there is some expectation that something will be agreed,” Bloomberg Intelligence strategist Laurent Douillet said by phone. “So the meeting of European leaders over the weekend is very important.”

Euphoric European Markets Look to Leaders to Strike a Deal

The rally in the euro and Europe’s riskier government bonds also started to gain traction in May and is contingent on an agreement between EU leaders over the fund. While the European Central Bank’s bond-buying programs have backstopped the region’s debt, President Christine Lagarde reiterated on Thursday that efforts to bolster economies are incomplete without a joint fiscal response and that it’s assumed that a deal will be approved.

“Our assumption is that the Recovery and Resilience Facility will come about and will be a strong mixture of grants on the one hand, in larger proportion than loans,” Lagarde said in a press conference Thursday. “My sense is that a very large number of leaders are perfectly aware of the importance of not wasting time.”

Still, the 27 leaders all need to be in agreement for the plan to move ahead and Austria, Denmark and Sweden have also voiced some of the concerns articulated by Rutte of the Netherlands. Consequently, not all investors expect rapid progress.

“The political willingness of the Germany-France axis to get the package in place is very big,” Markus Steinbeis, managing partner at Steinbeis & Haecker Asset Management, said by phone. “Capital markets know this, but are also used to the fact that things move slowly in Brussels and a solution is often reached at the last minute. Little progress on the weekend should cause a short-term disappointment, but hopes will remain.”

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