The EU raised 5 billion euros this week, selling bonds redeemable in 2048 with investors offering seven times the amount offered. A relatively juicy interest rate of 2.625% and a yield about 80 basis points above German levels and in line with French debt helped boost demand.
For the borrower, however, this compares to a €10 billion deal in 2050 issued in November 2020, which only came with a 0.3% coupon and a yield spread over to the then equivalent German benchmark by around 25 basis points. This security now trades at 53% of face value, illustrating how quickly the capital values of ultra-long-maturity, low-coupon debt can erode in a rising yield environment. Credit spreads, even for a supranational like the EU, have widened significantly relative to Germany; the bond market is not waiting for the European Central Bank to actually raise its negative official deposit rate by 0.5% before proceeding with a revaluation according to a modified monetary environment.
Having already raised almost 100 billion euros for its economic support package, the EU’s remaining borrowing needs by the end of 2026 puts its next issuance on par with Germany, France, Europe, and Germany. Italy and Spain. Its initial plan was to borrow 50 billion euros in the first half of 2022; even after Tuesday’s deal, it’s still only about half that pace, so it will take a lot more issuance later this year to stay on track with the annual capital-raising target of 150 billion euros which it reiterated in its May update – and at the prevailing higher yields.
The stark reality is emerging that pandemic recovery funding is likely to be far more costly than originally anticipated. Even at the end of last year, much of Europe’s debt was essentially free money. The EU’s average interest rate is still below 1%, with more than a third of its €295 billion in outstanding bonds repaying in more than 10 years. Having to pay coupons of 2% and above for medium and long-term debt will significantly alter its overall cost dynamics.
The rising cost of supporting nations such as Italy and Greece, with their already excessive debts relative to gross domestic product, will be felt across the continent with attendant political tensions. We’ve seen this movie before, so we’re going to have to think about the viability of the EU support mechanism if it doesn’t want to stumble over its first hurdle in the bond market. The creation of the package demonstrated European solidarity in its collective response to the pandemic; a similar cohesion will be needed in the months and years to come.
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Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.
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