- European Commission President Ursula von der Leyen will present her own proposal Wednesday, building on the Franco-German plan.
- A new coronavirus-related stimulus package could boost markets across Europe.
- One example of how this could manifest itself in markets is in government bonds.
- In addition, the euro could strengthen on the back of new European stimulus.
The European Commission will unveil Wednesday a new coronavirus-related stimulus package and expectations are that it could boost markets across Europe.
In what's been described as a "Hamiltonian moment" for Europe, Germany and France proposed last week to raise common European debt in an effort support the region's economic recovery from the coronavirus crisis. The announcement was particularly significant because Germany had been a fierce opponent to the idea of European debt — its change of heart suggests the EU could be moving closer to a fiscal union, an important factor of stability going forward.
European Commission President Ursula von der Leyen will present her own proposal Wednesday, building on the Franco-German plan.
"As proposed, the new EU recovery fund would mark an important turning point and lead to lower risk premia across the region," analysts at Morgan Stanley said in a note last week, after the Franco-German announcement.
This would likely impact government bonds, as lower risk means investors would become more confident in lending to indebted nations such as Italy and Spain, which in turn could reduce borrowing costs.
Peripheral bond yields have moved lower in the month of May as investors have digested the possibility of common European debt. On Tuesday, Italian 10-year bond yields fell to their lowest in almost seven weeks.
Meanwhile in currencies, the euro — the common currency used across 19 European countries — could strengthen on the back of new European stimulus.
"The Recovery Fund proposal should ease pressure on EMU (European Monetary Union) sovereign spreads for now, and also limit immediate depreciation pressure on the Euro," analysts at Goldman Sachs said over the weekend.
They added that if the EU legislates new stimulus on the basis of the Franco-German proposals this "could represent a major step toward greater ﬁscal policy coordination in the region" and make the euro more competitive against the U.S. dollar.
Equity markets could also benefit as the upcoming stimulus is expected to support businesses impacted by the virus, as well as help with the digitization and environmental transition.
It is uncertain how big the commission's proposed stimulus package will be, but the instrument proposed by Berlin and Paris is so ambitious that analysts believe, if implemented, it would reduce the pressure on the European Central Bank (ECB) as well as on individual governments.
"We see this as mitigating the risk of a southern slump and increasing the prospect of a synchronised recovery in Europe. Over time, we think that this reduces the pressure on national budgets and the ECB, and increases the likelihood of enhanced European fiscal capacity," the Morgan Stanley analysts said.
France and Germany suggested the European Commission should raise 500 billion euros ($550 billion ) in public markets and give that money as grants to the sectors most impacted by the pandemic. The allocation of these funds would be done via the European budget — a common basket that receives contributions from all 27 member countries and which finances projects across the region.
Market players will be watching the size, composition and conditionality attached to von der Leyen's proposal.
"Von der Leyen is likely to propose a fund above 500 billion euros," research firm Eurasia said in a note Friday, as upcoming negotiations with the 27 countries are likely to bring down the original target.
Though most countries in Europe have expressed their support for the Franco-German plan, four member states need more convincing.
Austria, the Netherlands, Sweden and Denmark said Saturday, in a document seen by CNBC, that new stimulus should be done via loans not grants. They also said these loans should have strings attached, such as "a strong commitment to reforms and the fiscal framework" and "adherence to Rule of Law."
Speaking to CNBC Tuesday, Thomas Weiser, a former European official, said "in the end they'll have to come together."
The 27 nations are expected to discuss the Commission's proposal in mid-June.
Weiser, who was president of the Eurogroup Working Group, also said it would be "bad economic policy" to favor a proposal that's more loans than grants.
The debate between loans and grants has divided European countries, with southern nations, which have higher debt piles, pushing for the latter as these would not impact their finances.
Wednesday's proposal is in addition to other stimulus measures agreed at the EU level. The ECB is already buying governments bonds and boosting lending, and European governments have previously agreed to an aid package worth 540 billion euros to help deal with high levels of unemployment, improve business activity and provide loans to governments.