European Union is the new ‘big beast’ on the bond markets

Europe Letter: ‘Outrageous’ demand by investors to buy EU’s debt seen as vote of confidence in euro

In uncertain times, investors cast about for ways to keep their money safe. Until now, the benchmark for such an investment has been German bunds: the debt issued by the federal government to finance its spending. There is never any shortage of takers, so Berlin has long enjoyed access to cheap debt.

But as of this week, there's another contender for that top status: the European Union itself.

With the help of banks Barclays, BNP Paribas, Deutsche Bank, Nomura and UniCredit, the European Union waded into the bond markets this week, hoping that its triple-A credit rating would attract investors to buy its debt.

To say it wasn’t disappointed is an understatement. Brussels looked to issue €17 billion in debt. Investors offered €233 billion. The debt issuance was over 13 times over-subscribed.

Bankers told the Financial Times this was the “largest ever order book in global bond markets”, a level of demand described as “outrageous”.

"The German bund has a serious rival," reported Bloomberg. "There's a big new beast on the debt circuit."

The wild amount of money that investors were prepared to offer the EU is taken to reflect two things: the demand for secure investments and a perception that the bloc can be counted on to ultimately repay the money.

Brussels hardly concealed its delight at this vote of confidence.

"We could have raised €233 billion, which is a sign of the great market interest and trust towards the EU as an issuer," EU budget and administration commissioner Johannes Hahn told a news conference.

‘Successful launch’

“The successful launch is a vote of confidence in the European Union as borrower and issuer and it will definitely strengthen the international role of the euro,” he added. “The emergence of a triple-A rated issuer, capable of issuing euro-denominated debt in such volumes has attracted much interest. This is a huge challenge and responsibility for us.”

The €17 billion in borrowing was to fund the first tranche of the European Commission’s “Sure” programme.

It stands for “Support to mitigate Unemployment Risks in an Emergency”: the money will be funnelled out as loans with favourable terms to member states, who will use it to help pay for job support schemes to prevent layoffs caused by the coronavirus pandemic.

Many member states have introduced initiatives like Ireland’s wage subsidy scheme to try to tide over employees and businesses and limit the economic destruction caused by the pandemic.

The Irish Government has so far chosen not to take part in the Sure programme, reasoning that it can borrow money for its spending directly from the markets itself, and so is not among the 17 member states including Belgium, Italy and Spain that will start receiving tranches of the cash.

But when it comes to issuing debt, the EU is only revving up its engines. It can raise up to €100 billion for the Sure programme, and may borrow up to €750 billion more under a landmark deal to fund member states’ economic stimulus plans and counteract the blow of Covid-19.

A milestone

Supporters of the joint borrowing plan saw it as a milestone towards fiscal integration in the EU, and a step towards fixing what economists describe as a structural flaw in the euro.

In the past, economically weaker members of the bloc have found themselves sucked into debt spirals in moments of turmoil, as they find themselves struggling to borrow at affordable rates. Investors flee to countries using the same currency, but that are seen as safer bets – an imbalance that has forced emergency bailouts and the European Central Bank to step in as a guarantor of the euro by buying up the bonds of struggling states.

Joint borrowing shares the responsibility for repayment between member states, meaning that weaker economies should enjoy more investor confidence and be able to borrow more cheaply.

The level of interest in the EU's bond issuance can be read as an expectation from markets that Brussels is likely to continue this kind of borrowing, according to Silvia Merler, a research associate at global asset management firm Algebris.

‘Market interest’

“I think the [European] Commission is right in taking it as a vote of confidence in the EU as an issuer, and EU leaders should read it as clear evidence of market interest in a genuine EU-level safe asset,” Merler said.

“As any safe asset is only as good as the institutional setting underpinning it, this enthusiasm is probably also a signal that investors expect these EU-level fiscal initiatives to become permanent, possibly turning into some form of future federal fiscal capacity.”

And Merler points to another opportunity. The euro is already the dominant currency for green bonds, which are issued to finance climate-related or environmental projects: 45 per cent of such instruments issued in 2019 were denominated in euro.

The European Commission hopes to finance some 30 per cent of the €750 billion in borrowing through green bonds, part of its efforts to support green initiatives and achieve climate neutrality for the continent by 2050.

“The EU has a real chance to boost the international role of the euro,” this way, according to Merler, “by consolidating it as the dominant currency in a market segment that will only grow more and more relevant in the future, especially post-Covid.”