Insight Article Desktop Banner
Market Pulse
Juli 24, 2020

The EU Recovery Fund: Maybe not Hamilton, but hopefully a quiet summer on the beach

Insight Video Mobile Banner
Juli 24, 2020

The EU Recovery Fund: Maybe not Hamilton, but hopefully a quiet summer on the beach

Market Pulse

The EU Recovery Fund: Maybe not Hamilton, but hopefully a quiet summer on the beach

Share Icon

Juli 24, 2020


The EU Recovery Fund is an imperfect compromise towards a more powerful central fiscal mechanism in the EU. While it would be misleading to see it as large-scale fiscal federalism, it creates the framework, and precedent, for substantial fiscal transfers. Investors are correct in seeing this as reducing euro sovereign credit risk. Along with substantial support from the ECB, we expect the Fund to help euro sovereign spreads test their tightest levels year to date.


The EU Recovery Fund: what was agreed

After a marathon negotiation session over the weekend, the EU Council reached a comprehensive deal on the EU Recovery Fund as well as the EU budget (MFF) for the next 7 years. Both are important but there was understandably more focus on the Recovery Fund given it is an innovation and was a source of contention leading up to the summit. On the Recovery Fund, the agreement was for:

  • A EUR 750bn package, made up of EUR 390bn in grants and the rest in loans.
  • Funds to be allocated on the basis of the expected growth reduction from the COVID epidemic
  • An emergency brake was introduced (to appease the “frugal” states), which means fund disbursements can be stopped if there are concerns about how they are being used
  • The funds are to be disbursed through the course of 2021 and 2022, with the grants funded through a series of new taxes (on plastic, carbon taxes, a digital levy, etc.)

So how important is this?

Optimists hail the deal as a “game changer”, a “Hamiltonian moment” at which the EU has moved to a federal fiscal system in which there is now a strong central fiscal capability which can respond to economic shocks to the EU, strengthening EU unity and reducing the sovereign credit risk of individual member states. Others are not so positive, pointing out that the resistance from some member states to the proposals hardly looks like the desire for greater unity, that the planned EU plan doesn’t significantly shift the fiscal burden away from individual states and the agreement is a compromise to keep the EU project alive rather than a visionary project to reform it and take it forward. We think the truth is somewhere in between.

This is what the EU does

The reality is that significant moves towards greater EU integration have tended to come haltingly, in response to crises, through long and tedious negotiations, and always with someone in the room objecting. Negotiating through the night, at multiple summits, is what the EU does, but once a new precedent has been set, it rarely seems to be reversed. For example, support mechanisms, bail-out facilities and the greater ECB powers created in response to the 2010-12 euro sovereign crisis have become standard tools for the EU. There is a warning here as well, though: while the previous crisis did lead to significant changes, not all the reforms advocated for strengthening the euro have been implemented. In particular, the banking union remains unfinished business, with the impetus for reform fading once the crisis eases.

Nonetheless, the Recovery Fund not only sets the precedent for large scale fiscal transfers, it has also created the architecture for a fiscal federal system. Even if this was not the intention of the agreement, EU policymakers will now find some bright new tools in their toolbox, in particular the ability to issue joint and several bonds on a large scale to fund fiscal expenditure. The temptation will be to use it more often. The creation of large EU grants and loans will inevitably bind members closer together, as weaker states will have more positive incentives to remain in the union, and stronger countries will not want to see them leave (if that means they default on their obligations).

Why, and how much, does this matter for financial markets?

The announcement this week had only modest impact on government bond yields, but that’s because the agreement was broadly in line with previous proposals, so had largely already been discounted by investors. Nonetheless, it has helped contribute to a generally tighter credit spread environment, which has primarily been driven by the scale and aggression of the ECB’s QE programme (and also more recently by better than expected economic data).

The elephant in the room

The reason for this is it helps answer the question that has been the elephant in the room for European fixed income investors for the last 8-10 years: when the next recession hits, will the fiscally weakest members of the Eurozone be able to carry on funding their deficits in the market at affordable interest rates? Will investors be prepared to carry on buying a country’s bonds if its debt/GDP rises above 150% and its economic outlook is challenged? Especially if the member state is a large one, the economic and financial disruption from a sovereign credit event would be so severe that one would anticipate the rest of the EU would be prepared to provide support, but, as we witnessed with previous crises, the EU can be slow in providing a compelling response.

Even if the purpose of this week’s agreement is not to provide large-scale fiscal transfers between member states on an ongoing basis(which it most certainly wasn’t), the market sees the EU Recovery Fund as setting a precedent for providing fiscal support to members who would otherwise experience fiscal stress. As currently agreed, it does not transform the funding position of any sovereign, but on the margin is still helpful.

What we expect

While most euro sovereign credit spreads are close to where they were at the beginning of the year, completely reversing the widening seen in March at the peak of the market stress, we do not think this compression is unwarranted. The combination of very accommodative monetary policy, along with the potential for far more EU-wide fiscal support, justifies the market’s pricing of reduced sovereign credit risk. If anything, over the coming summer months, when sovereign bond issuance tends to dry up, we expect to see spreads to fall further to at least the tightest levels seen this year. Declining government credit risk should also help euro corporate bond spreads tighten due to the decline in systemic risk.

Our hope is that proactive monetary and fiscal policies, along with an effective public health response to COVID-19, will allow Europeans to enjoy a peaceful summer on the beach.

Executive Director
Global Fixed Income Team


This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

Ireland: Morgan Stanley Investment Management (Ireland) Limited. Registered Office: The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, Ireland. Registered in Ireland under company number 616662. Regulated by the Central Bank of Ireland. United Kingdom: Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA, authorised and regulated by the Financial Conduct Authority. Dubai: Morgan Stanley Investment Management Limited (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158). Germany: Morgan Stanley Investment Management Limited Niederlassung Deutschland, Grosse Gallustrasse 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Italy: Morgan Stanley Investment Management Limited, Milan Branch (Sede Secondaria di Milano) is a branch of Morgan Stanley Investment Management Limited, a company registered in the U.K., authorised and regulated by the Financial Conduct Authority (FCA), and whose registered office is at 25 Cabot Square, Canary Wharf, London, E14 4QA. Morgan Stanley Investment Management Limited Milan Branch (Sede Secondaria di Milano) with seat in Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy, is registered in Italy with company number and VAT number 08829360968. The Netherlands: Morgan Stanley Investment Management, Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. Telephone: 31 2-0462-1300. Morgan Stanley Investment Management is a branch office of Morgan Stanley Investment Management Limited. Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Switzerland: Morgan Stanley & Co. International plc, London, Zurich BranchI Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered with the Register of Commerce Zurich CHE-115.415.770. Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland, Telephone +41 (0) 44 588 1000. Facsimile Fax: +41(0)44 588 1074.

Profession Clients Use only


EMEA: This marketing communication has been issued by Morgan Stanley Investment Management Limited (“MSIM”). Authorised and regulated by the Financial Conduct Authority. Registered in England No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

This document contains information relating to the sub-funds of Morgan Stanley Investment Funds, a Luxembourg domiciled Société d’Investissement à Capital Variable. Morgan Stanley Investment Funds (the “Company”) is registered in the Grand Duchy of Luxembourg as an undertaking for collective investment pursuant to Part 1 of the Law of 17th December 2010, as amended. The Company is an Undertaking for Collective Investment in Transferable Securities (“UCITS”).

Applications for shares in the sub-funds should not be made without first consulting the current Prospectus, Key Investor Information Document ("KIID"), Annual Report and Semi-Annual Report (“Offering Documents”), or other documents available in your local jurisdiction which is available free of charge from the Registered Office:European Bank and Business Centre, 6B route de Trèves, L-2633 Senningerberg, R.C.S. Luxemburg B 29 192.

In addition, all Italian investors should refer to the ‘Extended Application Form’, and all Hong Kong investors should refer to the ‘Additional Information for Hong Kong Investors’ section, outlined within the Prospectus. Copies of the Prospectus, KIID, the Articles of Incorporation and the annual and semi-annual reports, in German, and further information can be obtained free of charge from the representative in Switzerland. The representative in Switzerland is Carnegie Fund Services S.A., 11, rue du Général-Dufour, 1204 Geneva. The paying agent in Switzerland is Banque Cantonale de Genève, 17, quai de l’Ile, 1204 Geneva. The document has been prepared solely for informational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy.

Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

All investments involve risks, including the possible loss of principal. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

The views and opinions provided here are of the investment management team. These are not the views of the firm as a whole.

The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the applicable European or Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.

MSIM has not authorised financial intermediaries to use and to distribute this document, unless such use and distribution is made in accordance with applicable law and regulation. MSIM shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary. If you are a distributor of the Morgan Stanley Investment Funds, some or all of the funds or shares in individual funds may be available for distribution. Please refer to your sub-distribution agreement for these details before forwarding fund information to your clients.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without MSIM’s express written consent.

All information contained herein is proprietary and is protected under copyright law.

This document may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this document in another language, the English version shall prevail.


Nutzer müssen die Nutzungsbedingungen lesen und akzeptieren, da in diesen bestimmte gesetzliche und regulatorische Auflagen enthalten sind, die für die Verbreitung von Informationen zu den Anlageprodukten von Morgan Stanley Investment Management gelten.

Die auf dieser Website beschriebenen Dienstleistungen sind unter Umständen nicht in allen Rechtsgebieten oder für alle Kunden verfügbar. Weitere Einzelheiten können aus unseren Nutzungsbedingungen entnommen werden.

Datenschutz    •    Nutzungsbedingungen

©  Morgan Stanley. Alle Rechte vorbehalten.