As the European Union prepares bond sales for its pioneering COVID-19 recovery fund, the scale and duration of the loan program may disappoint those who had envisioned last year’s joint debt deal 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, which in turn polished the euro’s appeal. as reserve currency.
In short, some predicted, it would do for Europe what Secretary of the Treasury Alexander Hamilton did in 1790 for the newly formed United States: create a fiscal union.
That optimism seemed exaggerated even then. A year later, as the European Commission prepares to sell bonds to finance the € 800 billion fund, enthusiasm has been tempered by doubts about the fund’s potential to become permanent.
Without that, according to Chris Iggo, chief investment officer for basic investments at AXA Investment Managers, the issue is destined to be “a historical anomaly and the bonds will simply remain hidden in the portfolios of insurance companies.”
“This has to be something continuous, there has to be a permanent centralized borrowing capacity … otherwise, it becomes something unique that is not very interesting in the long term,” said Iggo, who helps manage 869 billion euros. euros.
“They will not trade and they will not be liquid.”
In its current form, loans from the recovery funds will end in 2026. The debt pile will shrink until the last bonds mature in 2058.
EU Budget Commissioner Johannes Hahn repeated this week that the bonds were a reaction to a one-time event. The fund was “a strong signal of solidarity” after the pandemic rather than a Hamiltonian moment, he said.
German government bonds are Europe’s benchmark fixed-income instrument, but at € 1.5 trillion, the market is a fraction of the $ 20 trillion outstanding in US Treasuries.
Some hoped that the debt from the recovery fund would form the basis of an issuance program to eventually create a risk-free asset that, along with the Bunds, would eventually rival the Treasury bonds.
EU Commission Vice President Valdis Dombrovskis recently hinted that a successful recovery fund offered scope to develop a permanent instrument. Germany’s Green Party, which is likely to join the next government, also wants the fund to be permanent.
And the EU has done the groundwork, creating a debt bureau and a network of primary dealer banks to administer the program and hold debt auctions. Some € 90 billion in bonds it has sold since October to support its SURE employment scheme are already trading higher as sovereign securities, enjoying solid liquidity.
But the richest EU states are likely to oppose any attempt to make the fund permanent, and even the current borrowing scheme took national parliaments six months to pass.
A more immediate risk is lower-than-anticipated issuance volumes, with banks forecasting only around 600 billion euros, 25% below the maximum amount.
This is because governments show little interest in borrowing from the fund, which is created for both grants and loans. Of the largest member states, only Italy so far has plans to use the € 386 billion credit line, according to Rabobank, although demand is likely to increase over time.
And old existential risks remain: without a fiscal union with a common budget and tax collection policies, the EU will remain a supranational borrower, rather than a sovereign.
Furthermore, the recovery fund lacks a “joint guarantee”, which means that, in the event of default, each member state will be liable only for a part, not for the entire debt.
Future crises may induce the EU to complete the fund, eventually leading to permanence, said Nicola Mai, a member of the European portfolio committee at PIMCO, one of the world’s largest asset managers.
“If, over time, you have a joint guarantee and more permanence, you can more strictly call it a sovereign-type issuer,” Mai said.
Until then, investors will demand a premium on German bonds to offset the lower risk of a euro breakout, further hampering the safe asset potential of EU bonds.
Currently, the EU pays 24 basis points more for 10-year debt than Germany.
Mike Riddell, who helps manage nearly € 600 billion at Allianz Global Investors, sees EU debt as the risk-free benchmark “only in an environment where there is full tax integration” .
“Germany will ultimately be the risk-free rate for the euro zone for the foreseeable future,” he said.
(Reporting by Yoruk Bahceli; Additional reporting by Dhara Ranasinghe; Edited by Sujata Rao and Catherine Evans)