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Europe's Debt Avalanche Is Just About to Start

Europe's Debt Avalanche Is Just About to Start

Wednesday, 16 June, 2021 - 03:45

The waiting’s over. The European Union has fired the gun on its multiyear bond issuance to fund the 750 billion-euro ($900 billion) pandemic recovery fund that the bloc agreed last summer.

Tuesday saw the launch of a benchmark 10-year deal and it met a rapturous investor reception. The offering was double what was expected, at 20 billion euros, and offers a yield a few basis points above zero — about 6 or 7 bps. That’s about 30 bps more than equivalent German debt. The order book was for a positively eyewatering 142 billion euros. A big new beast has arrived in the bond market.

The EU’s sales of 200 billion euros or more per year will rival the national issuance of Europe’s big four sovereign issuers: Germany, France, Italy and Spain. The bonds will reshape European capital markets, not least because a third of them will be green debt, adding hugely to the liquidity of that market and setting an example for national governments and corporates to follow.

Brussels has already done a fair amount of market testing by issuing about 100 billion euros of bonds to fund its SURE job support program. That injected much-needed cash into the EU while the pandemic recovery fund (known as NextGenerationEU) went through the approval process. The larger-scale financing is needed desperately to support Europe’s tentative recovery.

The European Commission has been an established — if infrequent — bond issuer, but the pandemic has altered its mindset on fiscal stimulus and on wealthier northern euro-zone nations helping out their southern neighbors through mutual debt and effective fiscal transfers. It’s very different to the austerity and harsh medicine of last decade’s sovereign debt crisis.

The Commission is the ideal body to roll out coordinated support at scale. There are 54 EU bond issues outstanding, compromising 143 billion euros and maturities out to 30 years, By the end of 2026 it will be close to 1 trillion euros. There’s also a possibility that programs get extended and increased if the recovery doesn’t get traction. The European Central Bank can buy up to half of any of these issues, so investors know there’s official support.

While the EU has gone down the popular syndicated sale route, using investment banks to run this inaugural NextGeneration sale, a primary dealer and auction system is also planned. This will help keep funding costs down and provide more regular access to liquidity for dealers.

For supporters of EU integration, it’s clearly a signal of intent that Brussels intends to be treated in the same way as the established major bond-issuing nations. Indeed, it has an eye on becoming the European benchmark on bond prices and yields. This won’t happen overnight but the preeminent status of German debt is restricted by the lack of free float as most outstanding Bunds are held by central banks and official institutions globally.

As the new EU debt trades at a modest yield premium above Bunds there’s an incentive now for investors to diversify their top-tier holdings. The bonds have an AAA credit rating from Moody's Investors Service, so they’re perfect collateral. One of the next steps will be to build out a shorter-term bill program for maturities out to two years, which can be used as collateral in derivatives. There’s also the prospect of exchange-traded futures and options referencing EU debt specifically.

Better late than never for the EU’s fiscal cavalry to have its capital-raising plans falling into place.

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