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Institutional Perspectives

Even though both European and U.S. economies have been shocked by the same COVID-19 virus, their fiscal responses are diverging in unique ways.

Unemployment rates in both Europe and the United States are set to jump more quickly than most investors have witnessed in a few decades. But, even though the economies of both regions are being hit by the effects of the COVID-19 virus, their fiscal responses are diverging in unique ways.

The difference between stimulus efforts in the United States and Europe is largely the result of  contrasting financial structures, labor market structures, and fiscal capacities.

Financial Structures
First, since Europe is primarily a bank-based financial system—meaning firms typically get loans from banks—a considerably larger feature of European stimulus is loan or liquidity guarantees. In contrast, since the United States is primarily a market-based financial system—meaning firms typically borrow from bond markets—more of the U.S. response is in the form of direct fiscal outlays with a large role for the U.S. Federal Reserve (Fed) in the form of the Term Asset-Backed Securities Loan Facility (TALF). The role of the European Central Bank (ECB) is less direct in Europe’s case, but still important as it is responsible for Outright Monetary Transactions (OMT), which maintain the functioning of Europe’s sovereign bond markets in a crisis.

Labor Market Structures
Second, many European countries already maintain programs that cover workers for short-term furloughs and avoid lay-offs. These programs are not widespread in the United States and, as a result, U.S. stimulus has included very generous outlays for unemployment insurance, for example, a $1200 cash transfer to workers and an additional $500 per child. The unemployment insurance system in the United States is the main entity for steering funds to workers and so U.S. political leaders, (through the Coronavirus Aid, Relief and Economic Security Act (CARES Act), signed into law on March 27), decided to enhance this system beyond all historical parallels to get funds quickly to workers. In contrast, such programs already exist in Europe, and European leaders have opted for more tax deferrals for businesses.

Fiscal Capacities
Lastly, and certainly not least, there is a different starting point for perceived fiscal capacity in the United States and Europe. I say “perceived” because economists are not entirely sure what level of debt causes a country to run into trouble with its creditors. And countries that hold status as reserve currencies tend to have more room for debt than other countries. Figure 1 summarizes the planned fiscal measures of different countries in response to COVID-19.

 

Figure 1.  The Disparities are Clear in the Fiscal Responses of Europe and the United States
Percentage of 2019 GDP (as March 26, 2020)

Source: Federal Reserve Economic Data, Bruegel, and the European Commission.  GDP=Gross domestic Product.

 

Economic Impact in Europe
One could argue that the direct fiscal spending of Spain and Italy is too small, given how strongly they have been affected by COVID-19. This is a sign that they are somewhat fiscally constrained. Whether or not pooling risk together and issuing “coronavirus bonds” backed by the collective eurozone is an acceptable means of providing additional fiscal heft for countries like Spain and Italy is a current issue among European countries. In my opinion, it is the defining issue of the crisis for Europe.

 

Figure 2. The ECB’s Systemic Stress Index is reading at some of its highest levels over the past decade.
ECB Systemic Stress Index readings (1999–March 27, 2020)

Source: European Central Bank. The ECB Systemic Stress Index attempts to measure the state of the eurozone financial system in real time.

 

In the meantime, markets await an answer. Surveys released by Eurostat indicate a significant blow to the eurozone’s economy from COVID-19. Announcements from country labor ministries suggest an intense period of furloughs, such as France’s Labor Ministry announcing that 337 thousand businesses have put 3.6 million workers on paid furlough. In the UK, half of companies are planning to furlough their staff, according to the Financial Times. The ECB’s prior actions—announcing a Pandemic Emergency Purchase Program (PEPP)—have provided some breathing room, but financial conditions are in rougher territory. The ECB’s Systemic Stress Index is reading at some of its highest levels over the past decade.

The total impact of the pandemic on European and U.S. economic growth and the validity of each region’s fiscal response is yet to be determined.

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Glossary of Terms

Outright Monetary Transactions (OMT) is a program of the European Central Bank under which the bank makes purchases (outright transactions) in secondarysovereign bond markets, under certain conditions, of bonds issued by eurozone member-states.

The Pandemic Emergency Purchase Program (PEPP) was launched on March 18, 2020 as a temporary asset purchase program of  private and public sector securities to counter the risks to the monetary policy transmission mechanisms posed by the outbreak of the coronavirus, COVID-19..  The program has an overall envelope of  €750 billion and will remain active until the end of 2020.

The Term Asset-Backed Securities Loan Facility (TALF) was a funding facility that helped market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by loans of various types to consumers and businesses of all sizes. The TALF began operation in March 2009 and was closed for new loan extensions on June 30, 2010. The final outstanding TALF loan was repaid in full in October 2014.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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