EU debt suffers under competition with sovereign borrowers

The EU is paying more to borrow with its joint bonds than the bloc’s leading members, denting the appeal of common issuance and emboldening opponents of fresh debt sales.

During the global bond sell-off of the past year, the EU’s borrowing costs rose more swiftly than those of many member states. A year ago the yields on common debt issued by the European Commission sat between those of Germany — the bloc’s haven — and those of France.

Today, they have risen above French borrowing costs, even though the EU’s triple-A credit rating outshines Paris’s double-A status. Ten-year EU bonds currently yield 2.63 per cent, more than France’s 2.54 per cent.

At shorter maturities, Brussels’ yields are even higher than those paid by Spain and Portugal — long considered among the bloc’s riskier debt markets. Italy’s yields, however, remain higher than those on EU bonds.

The relative shift in borrowing costs is small, and investors say it does not reflect concerns about Brussels’ creditworthiness. Even so, its symbolic importance has emboldened opponents of fresh common EU debt. German finance minister Christian Lindner has pointed to the premiums when arguing member states should do their own borrowing. It is also a potential setback to hopes that expanded EU borrowing could provide a shared safe asset for the euro area, deepening the bloc’s capital markets and boosting the international role of the euro.

“The underlying weakness is that these bonds are effectively competing against all the sovereign bond markets in the eurozone,” said Antoine Bouvet, a rates strategist at ING.

The EU is in the midst of an unprecedented wave of common debt sales, triggered by the need to create a common response to the coronavirus-related economic slump in 2020. Some member states back new sales of European Commission debt as a way of supporting the green transition and countering the competitive disadvantages generated by the US’s $369bn Inflation Reduction Act.

The upward shift in the commission’s yields reflects investors’ perception of the EU as a debt issuer belonging to a group of so-called supranationals — including pan-EU agencies such as the European Investment Bank and the European Stability Mechanism, the region’s bailout fund.

Bonds issued by these bodies are typically less heavily traded than sovereign debt, and do not form part of the government bond indices tracked by many big investors. As such, they tend to underperform government debt in adverse market conditions such as in 2022’s big bond rout.

Brussels’ current borrowing plans put it on course to eclipse all but the largest EU sovereign issuers, and it has adopted many of the trappings of a sovereign issuer such as regular bond auctions run by a network of bond-dealing banks. The commission completed its first bond sale of 2023 on Tuesday, raising €5bn from a sale of 30-year debt.

Nevertheless, the EU has struggled to shift its supranational tag. Bankers and investors price the debt relative to interest rate swaps — as it is typical for the sector — rather than using German debt as a reference point.

There is currently no sign of Brussels’ bonds supplanting Berlin’s as a benchmark that could eventually become the eurozone’s answer to the vast US Treasury market, which plays a central role in the global financial system.

“ace [EU debt is] going to replace sovereign bonds for the foreseeable future it’s just a further segmentation of the market — it actually takes you further away from something that resembles the US Treasury market,” ING’s Bouvet said.

Bouvet added that EU bonds lacked the “domestic preference” — investors and banks that prefer buying debt issued by their own government — which provides a key source of demand for bonds, particularly at shorter maturities. “A conservative German bank Treasury will always favor German debt; the same for a French bank,” he explained. “That really makes this an uphill struggle for these bonds to trade like a true safe asset.”

Traders said the situation will not be easy to resolve. “There’s still this perception with investors that this is a non-permanent presence in bond markets,” said the head of government and supranational bond trading at a major European bank.

Futures contracts linked to German, French and Italian bonds help to improve liquidity and attract a wider range of investors.

But exchange operators may be reluctant to launch something similar for EU debt, given doubts about the scale of issuance after 2026, the trader said. The union insists that the NextGenerationEU program is a one-off scheme, reducing the prospects for large amounts of issuance in the future.

The commission as of this month uses what it calls for a unified funding approach under which it raises money for various priorities under a single EU bond label. It hopes this will help liquidity in the markets.

“These measures will make EU securities more liquid, and improve their pricing and trading in the secondary market,” the commission said.

“The difference in pricing does not mean investors are concerned about the EU as an issuer. On the contrary — investors continue to demonstrate a strong interest in and appetite for the EU Bonds, as reflected in the regularly high oversubscription levels for EU bonds.”

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