Why Common Bonds Signal a New Era for Europe
The following text is an article published by the Wall Street Journal on July 22nd, 2020. It is important to take note of the European version of US Treasury Bills. It has implications for the dollar, for the future competition America will have in fixed income markets, and for the global economy. Legitimized by the generally perceived need to support the economy in response to COVID-19 lockdowns, governments and central banks around the world are taking financial repression to a whole new level.
The European Union took a giant step toward selling hundreds of billions of euros in common bonds for the first time. The proposed issuance is part of a €1.8 trillion ($2.1 trillion) spending package to combat the recession caused by the coronavirus, hammered out by the region’s leaders in the early hours of Tuesday.
Why does the EU plan to issue bonds?
Leaders from the EU’s 27 nations authorized borrowing up to €750 billion from capital markets—an unprecedented step for the bloc—to finance a recovery fund that will aid countries suffering because of the pandemic. In the current proposal, one criterion for funding commitments under the recovery program in 2021 and2022 will be unemployment in 2015–19.
Source: Eurostat, Wall Street Journal Funds will be funneled to nations that have endured the biggest hit from coronavirus, with the debt-laden southern European countries likely to be among the biggest beneficiaries. After pushback from the Netherlands and other thrifty members, leaders agreed to distribute €390 billion of the fund as grants, and €360 billion as loans.
Investors say the sale of common bonds would represent a move toward the kind of economic integration required to ensure the eurozone’s long-term survival.
Would this be the first time the EU has issued bonds?
No. But the EU has never borrowed money on such a scale, nor been able to spend the proceeds so freely. The bloc has issued debt to finance a handful of targeted economic programs, most notably one that bailed out Ireland and Portugal in 2011-14, during the eurozone’s sovereign-debt crisis. It has around €52 billion in outstanding debt instruments, according to the European Commission. Other European bodies that are autonomous or legally distinct from the EU, including the European Investment Bank, have also borrowed in the capital markets.
This time, all the money borrowed by the EU must be used to combat the fallout from Covid-19. Given the scale of the crisis, that provides significant leeway. The bulk of the money will be spent on “recovery and resilience” plans submitted by national governments and targeting jobs creation as well as supporting digital and climate-change initiatives.
Debt as a percentage of GDP in select European Union countries
Source: European Commission, Wall Street Journal
Why are investors interested in these bonds?
The bonds could help solve a problem that has bedeviled investors in the region for years: the absence of a European equivalent to U.S. Treasury’s, considered among the safest assets to hold. German bunds have long been used as a proxy, but a shortage of those bonds has pushed their yields to well below zero.
“Producing more high-quality safe assets isn’t going to be a problem for the market to digest,” said Adrian Hilton, head of global rates and currencies at Columbia Threadneedle Investments. Columbia would buy the bonds, he added.
Both Fitch Ratings and Moody’s Investors Service give the bloc their top credit ratings, while S&P Global Ratings grants it AA, two rungs below the highest investment grade.
Insurers and pension funds, banks and fund managers are likely to pile into the EU bonds, judging from holders of the region’s debt at allocation. Each group has bought between 20% and 29% of the debt the EU has issued since 2011, according to an investor presentation by the European Commission in July.
European Union benchmark bonds, amounts outstanding maturing each year
Source: European Commission, Wall Street Journal
Who will issue the common debt and for how long will they borrow the money?
The European Commission, which is the EU’s executive arm, will sell the bonds and will be required to stop issuing new debt, net of repayments, at the end of 2026. EU leaders have said it should pay off the debt by 2058.
Where and how are the bonds likely to trade?
They will likely trade on the Luxembourg Stock Exchange, where existing EU bonds are bought and sold.
Investors say they will probably pay roughly what existing 10-year EU bonds offer, which is the same yield as French government debt. That is about minus 0.152% for a 10-year bond, or around 0.3 percentage points higher than on German bonds.
Could the European Central Bank buy the bonds?
Yes. The ECB has already bought bonds issued by the European Investment Bank and EU bailout programs and would be able to buy up to half of new issues under the recovery fund.
What is next?
The package still needs approval from the European Parliament and individual member states, some of which will put the plan to their national lawmakers. A green light isn’t guaranteed and could take until late this year. Still, analysts are confident the package will be approved.
“It’s a very carefully crafted compromise,” said Carsten Nickel, Europe analyst at consulting firm Teneo. “Jeopardizing that is too much of a political risk for the European Parliament, given the magnitude of the current crisis.”