As the EU prepares its first payback obligation, a reality check of hopes for a “safe asset”
As the European Union prepares bond sales for its pioneering COVID-19 stimulus fund, the scale and duration of the borrowing program may disappoint those who had considered last year’s debt deal common as the Hamiltonian moment of Europe.
Agreed in July as the pandemic raged, the deal raised hopes among investors that Europe would finally have a large, liquid ‘safe’ asset to compete with US Treasuries, in turn bolstering the attractiveness of the euro as a reserve currency.
In short, some predicted that it would do for Europe what Treasury Secretary Alexander Hamilton did in 1790 for the newly formed United States: create a fiscal union.
Such optimism already seemed exaggerated. A year later, as the European Commission prepares to sell bonds to fund the € 800 billion fund, excitement has been dampened by doubts about the fund’s potential to become permanent.
Without it, according to Chris Iggo, chief investment officer for core investments at AXA Investment Managers, the issue is destined to be “a historic anomaly and the bonds will simply be hidden in the portfolios of insurance companies.”
“It has to be an ongoing thing, there has to be continuous centralized borrowing capacity… otherwise it becomes a one-off thing that isn’t very attractive in the long run,” said Iggo, who helps manage $ 869 billion. euros.
“They won’t trade and they won’t be liquid.”
As it is, the stimulus fund borrowing will end in 2026. The debt pile will then decrease until the last bonds mature in 2058.
EU Budget Commissioner Johannes Hahn reiterated this week that bonds were a reaction to a one-off event. The fund was “a strong signal of solidarity” following the pandemic rather than a Hamiltonian moment, he said.
German government bonds are the benchmark fixed income instrument in Europe, but at 1.5 trillion euros, the market is only a fraction of the $ 20 trillion outstanding in US Treasuries.
Some had hoped that the debt of the stimulus fund would form the basis of an issuance program to eventually create a risk-free asset that, alongside Bunds, would eventually rival Treasuries.
The Vice-President of the European Commission, Valdis Dombrovskis, recently hinted that an effective stimulus fund offered the possibility of developing a permanent instrument. The German Green Party, which is expected to join the next government, also wants to make the fund permanent.
And the EU has done the preparatory work, creating a debt office and a network of blue chip banks to run the program and hold debt auctions. Some 90 billion euros in bonds he has sold since October to support his SURE employment program are already being treated more like sovereign securities, benefiting from strong liquidity.
But wealthier states in the EU are likely to oppose any offer to make the fund permanent, and even the current borrowing plan has taken national parliaments six months to approve.
A more immediate risk lies in lower than expected issuance volumes, with banks budgeting as little as around € 600 billion, or 25% less than the maximum amount.
This is because governments show little interest in taking loans from the fund, which is set up to provide grants as well as to lend. Of the larger member states, only Italy is planning to use the € 386 billion loan facility so far, according to Rabobank, although demand is likely to increase over time.
And old existential risks remain – without a fiscal union with common fiscal and fiscal policies, the EU will remain a supranational rather than a sovereign borrower.
In addition, the recovery fund does not have a “joint guarantee”, which means that in the event of default, each Member State will be liable for only part and not all of the debt.
Future crises could prompt the EU to top up the fund, eventually leading to permanence, said Nicola Mai, member of the European portfolio committee of PIMCO, one of the world’s largest asset managers.
“If over time you have a joint and several guarantee and more permanence, you can more strictly call it a sovereign type issuer,” said Mai.
Until then, investors will demand a premium against the German Bund to offset any risk of the euro breaking out, further hampering the safe asset potential of European bonds.
Currently, the EU pays 24 basis points more on 10-year debt than Germany. EU000A283859
Mike Riddell, who helps manage nearly € 600 billion at Allianz Global Investors, sees EU debt becoming the benchmark for risk-free “only in an environment where you have full tax integration”.
“Germany will ultimately be the risk-free rate for the eurozone for the foreseeable future,” he said.
Source: Reuters (Reporting by Yoruk Bahceli; Additional reporting by Dhara Ranasinghe; Editing by Sujata Rao and Catherine Evans)