Page 20 - ISQ October 2022

INVESTMENT STRATEGY QUARTERLY

all EU members. According to Mr Laurent Ruseckas, executive In response to these and other threats, the Commission may
director of S&P Global, the proposals are extremely complex in have to announce a second regional Recovery Fund, much
practicality and impossible to work through in time for winter, larger in size than the current €800bn Fund. This, in turn, may
even if there were a political consensus behind them. ultimately require the regional central bank already raising key
interest rates and actively looking to shrink the size of its
Politically speaking, the successful functioning of the EU has balance sheet to recommence its earlier quantitative easing
been constructed on two pillars. The first is German growth programme. It is this expectation that seems likely to limit the
(the regional engine room), and the second is a combination of scope for regional sovereign bond yields to rise too far beyond
low-cost debt, highly supportive regional budgeting and a prevailing levels. The region’s stock markets, with a clear
TARGET 2 regional bank clearing system aimed at ensuring that cyclical bias, are thought unlikely to perform until evidence of
the region’s weaker economies can survive without being an economic upturn starts to emerge, that or the US dollar
forced into politically (and socially) unacceptable reforms.
starts to depreciate on the foreign exchanges.
The present-day reality reveals that the sharp slowdown in the
global economy, coupled with a profound energy crisis,
threatens both regional industrial activity and standards of KEY TAKEAWAYS:
living. This, in turn, limits the scope and desire for multilateral • Europe’s energy crisis has dominated investor
economic support whilst simultaneously increasing the desire sentiment and determined political initiatives and
for political self-determination at home. Nowhere is this more exacerbated regional inflationary pressures and
apparent than in Italy. growth slowdown.

Irrespective of pledges made on the campaign trail by the • Apparent acts of sabotage on the Nord Stream gas
victorious right-of-centre coalition, yields on Italian debt have pipelines have refocused attention on Europe’s lack
edged higher. Whilst the spread between Italian government of energy security, whilst ensuring that the Ukraine
bond yields and core (German) counterparts has risen, conflict remains front of mind.
implying that investors are seeking a risk premium for Italian • Commission plans to manage energy costs carries
bonds, they have not blown out to the levels of the past, at the risk that suppliers may not invest in additional
least not yet. That being said, Italy’s indebtedness is very high capacity and do little completely to protect
at around 150% of GDP, while its maturity profile is also households from rising energy bills.
unfavourable (35% of outstanding debt will fall due for
repayment in 2024 and 50% within five years). Without the • Political disunity threatens to fracture regional
latent support in the form of the, as yet unutilised, European cohesion. The Italian election result being merely the
Central Bank’s newly minted anti-fragmentation Transmission highest profile indication of popular discontent.
Protection Instrument yields would likely have blown out even • The ECB has embarked on a rate hiking programme
further than is currently the case. in an effort to contain regional inflationary pressure,
whilst standing ready to utilise its new anti-
Elsewhere, both Poland and the Czech Republic have made fragmentation tool were peripheral sovereign bond
clear their objection to plans to cap the price of Russian energy, yields to rise too sharply, too fast.
a proposal which seems unlikely to be enforced. Beyond this,
much-needed disbursements from the regional Recovery Fund
are increasingly being made conditional on adherence with Ms
von der Leyen’s “European values”, a list of essentially political
requirements aimed at subjugating regional nation states to an
unelected cadre in Brussels. This is not popular. Poland’s
governing Party secretary-general has recently warned that
“without a clear change in the actions of Brussels, we will have
no choice but to pull out all the cannons in our arsenal and
open fire”.

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