Analysis-Ukraine crisis another nudge for joint EU bonds -Breaking
© Reuters. FILEPHOTO: The flags of Ukraine and European Union are seen flying outside the EU Parliament building in Brussels, Belgium. February 28, 2022. REUTERS/Yves Herman
By Dhara Ranasinghe
LONDON, (Reuters) – The road to permanent bond sales by the euro zone governments is long and difficult. However, Russia’s invasion in Ukraine could have eased some of this.
European countries have pledged to increase their investment in renewable energy and defense, which many feel will make the world a better place.
While the European Union already has joint bonds in place for 800 billion euros ($879bln), post-COVID, they have not yet mentioned plans to issue additional debt.
Investors are still interested in the idea of a permanent plan. However, they have not forgotten about it. Many investors buy bonds from the countries most likely to benefit, like Italy, even though this isn’t an obvious prospect.
Christian Odendahl is the Centre for European Reform’s chief economist. He sees this war (which Moscow refers to as a “specially military operation”) as an opportunity for Europe to turn a corner, even though the path ahead remains uncertain.
Odendahl stated that it would have an impact on European integration “as much or more than the COVID crises helped propel a common fiscal capacity and borrowing which were unimaginable back when corona wasn’t a beer.”
The argument for joint bonds is that they would show European solidarity. Joint bonds would raise the profile of the euro and increase the European stock of high-rated securities. They could also be used to help the U.S. Treasuries compete as global reserve assets.
The spending requirements will become enormous with Germany alone promising a 100-billion euro military overhaul. According to JPMorgan (NYSE) estimates, if all NATO member countries commit to spending 2% on defense, then overall expenditures will increase by a quarter. This is the largest boost in 30 years.
BofA estimates that this could result in additional 150-200 Billion Euros of spending across the euro zone by 2022-22.
The European Commission’s plans to cut Russian gas ties would add more than 130 Billion euros per year to its already high-priced energy bill.
Even though more EU members are likely to be unwilling to bear those expenses alone, this joint bond debate speaks also to the shifts caused by the COVID collapse. Even among the most frugal countries, it brought attention to fiscal policy’s crucial role in times of crisis.
Arguments now suggest that, just like COVID and COVID, war is an exogenous event that impacts all EU nations, so a coordinated response will prove more effective than any series of individual national responses.
Christoph Rieger, Commerzbank’s Head of Rates, stated that the latest crisis is similar to COVID and a trigger for greater integration. He also said that “a permanent, joint EU debt capacity” was becoming increasingly likely over time.
NORTH & SOUTH
France has led calls to increase EU debt while Germany, Germany, and other members of the richer bloc are against any attempt at a fiscal union that includes shared borrowing and spending.
They argue that the Next Generation EU (NGEU) — the recovery fund, bonds sales for which started last year — mostly remains unused, with just 74 billion euros disbursed so far.
The current situation is that recovery fund borrowing will end in 2026, and the final bonds will mature in 2058.
Francesco Papadia (ex-director of market operations for the ECB) says that while this fund is a precedent it isn’t an ordinary tool. He is also a senior fellow at Bruegel Institute.
“(Joint Bonds) are only possible in exceptional circumstances…when it will be considered indispensable to effectively address the crisis,” Papadia added, adding that he is not certain the war has been declared.
Analysts from ING believe that less-expensive joint borrowing may be acceptable for “frugal” countries, as a result of the EU’s SURE unemployment program.
The recent behavior of bond markets shows how the common fund has helped to increase the bloc’s resilience.
Premium investors require that bond spreads be maintained from Spain and Italy. This is because they are more likely to demand bonds in trouble. Since the February 24th invasion, however, 10 year spreads for Italy have fallen 26 basis points.
Italian premia are now lower despite the conflict, at the same time that the European Central Bank intends to decrease the stimulus, which is an important support tool for southern Europe.
The 2020 lesson is that although the ECB may stop spread-widening, a true turnaround came down to how the EU responded, Citi analysts pointed out.
BofA estimates that the NGEU created a 33 bps gap in the spread between Italian and German, which BofA believes is a significant improvement over what it would otherwise have been.
Following recent media reports that suggested a possible new EU bond scheme, both the Greek and Italian spreads were sold at 10bps.
“The market will be more convinced that the EU…will eventually reach fiscal union if it understands that this is possible because there is enough political capital every time they are challenged.” Peter Chatwell from Mizuho is head of the multi-asset strategies.