London – There’s a new kid in debt town, with the closest thing so far to a true "euro bond” about to be sold in prodigious size to pay for the European Union’s new €750 billion ($869 billion) pandemic fund. It will represent a challenge to Europe’s undisputed credit-market champion: the German bund.
Germany’s government bonds have long been the continent’s benchmark for quality. They’re the equivalent to U.S. Treasuries as offering the safest collateral — and are regarded essentially as risk free. But the new EU bonds, to be sold and managed by the European Commission, will provide an alternative, and one that investors will welcome.
Bunds are very expensive, with yields on 10-year notes as low as the European Central Bank’s minus 0.5 percent overnight deposit rate. The commission will doubtless offer better returns on its new issues, and the same feeling of security. German debt is priced at a premium to other Eurozone bonds, but this will probably narrow now that something else is available.
While Berlin won’t be pleading poverty any time soon, it still has to pay for one of the world’s biggest fiscal responses to the coronavirus crisis — estimated at €1.5 trillion so far. Yet Germany is the country that’s probably furthest behind in its debt issuance for the year, according to NatWest Markets strategist Giles Gale, who sees 10-year bund yields climbing into positive territory in 2020. The higher borrowing costs implied by that would have an impact.
The EU pandemic bond, meanwhile, is already winning friends before its first issue. S&P Global Ratings has described it as "a breakthrough for EU sovereign creditworthiness.” This suggests that the commission may well retain its current AA debt rating from S&P. Moody’s Investors Service and Fitch Ratings award it AAA.
So the new bonds may gradually take over from the bund as the euro-debt benchmark. Amundi SA, the largest European investment manager, says they "should encourage foreign investors to consider the EU as a whole and not as the puzzle of single issuers.”
The pandemic debt will have decent liquidity too. Citi strategist Michael Spies reckons the EU could issue nearly €200 billion next year. This is less than Italian, French and German plans but it’s of a serious scale. Before long there may even be derivatives related to it.
And investors will be reassured that the ECB will be able to buy these bonds as part of its quantitative-easing programs. Up to 50 percent of each issue can be purchased by the central bank, a higher ratio than for individual nations’ debt.
At the same time, Germany can no longer rely on its famed parsimony for propping up the value of bunds. It will raise a record €220 billion in new money this year, reversing years of reducing its overall debt, and it will lift its ratio of debt to gross domestic product to 77 percent in the process. It was less than 60 percent previously.
The "black zero” rule — where Germany’s budget had to balance fiscal spending and tax receipts — is fast disappearing. That bund premium may no longer be so handsome if the EU upstart grabs market share.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
In a time of both misinformation and too much information, quality journalism is more crucial than ever.
By subscribing, you can help us get the story right.