Last week was one of contrasting fiscal policy fortunes between the eurozone and the United States, with the eurozone apparently taking a big step forward to deal with its design flaws and the US appearing to struggle with the challenges of gridlock in an election year. This narrative has helped the euro reach its highest levels against the US dollar since 2018, as the greenback struggles against a broad basket of currencies, with even returning risk aversion unable to help it much.
The main headline-grabbing event of last week was the EU budget deal reached by the European Council, which featured a €750 billion (Dh3.2 trillion / US$874.2bn) recovery fund, known as 'Next Generation EU'.
Climbdowns by the so-called ‘frugal four’ of the Netherlands, Austria, Sweden and Denmark will see the EU for the first time borrowing from capital markets to finance its expenditures, moving the 27-member bloc further along the path of fiscal integration. However, the deal also reduced the overall amount of grants to Covid-affected countries to €390bn from an original proposal of €500bn, but increased the amount of loans to €360bn from €250bn.
As ever with EU compromises, the headlines were probably more encouraging than some of the details. Anybody who expects this fund to result in a sudden boost to EU growth will likely be disappointed, as €750bn is a relatively small fraction of the eurozone economy and 70 per cent of the grants will not be disbursed until 2021 and 2022, and the rest in 2023.
Debt issuance is also scheduled to end in 2026, casting doubt on whether this will be a permanent arrangement. Furthermore, the overall budget has to be ratified by the EU Parliament and by individual EU Parliaments, and may yet face opposition from some countries.
In fact, according to some analysts, it will be the bigger countries like France and Germany that will benefit the most from the overall budget rather than the smaller indebted economies of the periphery, for whom the fund is intended. The euro benefited from the promise of fiscal integration, but it still largely remains a promise and not yet the real thing.
The progress from the EU is in contrast to developments in the US, where negotiations over a fresh round of spending have stalled. The delay was caused by Senate Republicans abandoning their plan to unveil a coronavirus relief bill after failing to agree with the White House on direct cash payments and extending unemployment insurance.
The legislation should now be released this week, but original expectations of it being in excess of US$1tn have been reined in. In a week when America’s Covid-19 infections passed 4 million and the number of deaths rose to nearly 150,000, the delays were hardly constructive, especially as new jobless claims still exceeded 1 million.
The coming week will see the full extent of the economic devastation wrought by Covid-19 lockdowns on the US in the second quarter, with the consensus estimate being for the US economy to contract by almost 35 per cent on a quarter-on-quarter seasonally adjusted annualised basis.
However, beyond the optics of the EU making progress on fiscal integration and the US being frustrated by gridlock, what should not be overlooked is that overall US fiscal impulse this year is at nearly 12 per cent of gross domestic product, far outweighing that of the eurozone, which will really only start in 2021.
And it is for this reason that the US dollar is struggling; not that the US is falling behind Europe in its coronavirus response. With the US 10-year Treasury yield slipping to 0.58 per cent last week, not far from the record low of 0.54 per cent posted in March, and with the 10-year real yield at its lowest level since 2012, it is not surprising the US dollar fell nor that the euro rallied along with most other currencies.
The US budget deficit is on track to reach 20 per cent of US GDP in the current fiscal year, while its debt-to-GDP will rise above 100 per cent. With US real yields negative, even with market risk aversion coming back, it is getting increasingly hard for the US dollar to benefit, let alone resist encouraging eurozone news.
Tim Fox is a prominent regional economist and financial market analyst