Filenews 24 June 2022
By Marcus Ashworth
It is reassuring that the European Union continues to enjoy strong investor demand for the debt it is selling in order to finance the €800 billion Pandemic Recovery Fund (NextGenerationEU).
Less welcome is the nearly 10-fold increase in its financing costs compared to what it was paying at the height of the pandemic. Soaring inflation will make it much more costly to support the bloc's economy, spreading the pain of higher yields across the European periphery.
The EU raised €5 billion this week, selling bonds maturing in 2048, with investors bidding for seven times the amount on offer. A relatively "juicy" interest rate of 2.625% and a yield about 80 basis points higher than that of German bonds, i.e. close to that of French debt, helped to stimulate demand.
The scenery has changed
For the collective European borrower, however, this compares to a €10 billion deal for 2050 maturing bonds issued in November 2020, which came with a coupon of just 0.3% and a yield difference with the corresponding German benchmark of that period of about 25 basis points.
This security is now trading at 53% of its face value, demonstrating how quickly the capital values of ultra-long and low-coupon debt can be eroded in an environment of rising yields.
Credit spreads, even for a supranational entity such as the EU, have widened considerably vis-à-vis Germany. The bond market does not expect the European Central Bank to substantially increase the negative official deposit rate of 0.5% to revalue in a changing monetary policy environment.
The spread of EU debt yields relative to that of Germany has been steadily widening over the last two years
Slow down versions
Having already raised almost €100 billion for the financial support package, the remaining EU borrowing needs by the end of 2026 put its upcoming issuances in the same field as those of Germany, France, Italy and Spain.
Its original plan was to borrow €50 billion. in the first half of 2022. Even after Tuesday's auction, it is still around half that pace, so it will take much more issues later in the year to continue the annual target of raising funds of €150 billion that the Union reaffirmed in the relevant update in May - and indeed under the prevailing higher yields.
The brutal reality that is dawning is that financing the recovery from the pandemic is likely to be significantly more expensive than originally predicted.
Even just at the end of last year, much of the European debt was essentially free money. The EU's average debt yield is still below 1%, with more than a third of outstanding €295 billion bonds repayable in more than 10 years.
The obligation to pay vouchers of 2% or more for debt of medium to long duration will significantly change the overall dynamics of these costs.
The entire EU debt yield curve has moved higher in 2022
Pressures
The rising costs of supporting countries such as Italy and Greece, with their already excessive debts in relation to their Gross Domestic Product, will be felt throughout the continent, with concomitant political pressure.
We have seen this work in the past, so some thoughts will have to be made about the viability of the EU support mechanism if the Bab 27 does not want to stumble upon the first hurdle it will encounter in the bond market.
The creation of the Recovery Fund was proof of European solidarity in the field of the collective response to the pandemic.
Similar signs of cohesion will be required in the coming months and years.
Source: BloombergOpinion
