- To combat the consequences of the Covid-19 pandemic, the EU is financing aid programmes ("Next Generation EU" and "SURE") worth up to €850 billion over the coming years.
- This is the first time that the EU has engaged in large-scale fundraising on its own account on the bond markets, where it will become one of the largest borrowers in the euro area.
- This will have consequences for the market in top-rated bonds and should also benefit investors.
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The bond markets are in crisis. Yields on listed German government bonds show how bad the crisis is. With the exception of ones that mature after 2046, all German bonds had negative yields at the end of August.[1] This means that anyone who has one of these bonds in their portfolio right now must pay a fee for the high level of security that German government bonds offer. Germany is after all one of the few countries in the world with an excellent credit rating. It has a top rating from the three major credit rating agencies, Fitch Ratings, Moody's and Standard & Poor's, making German government bonds the current quality benchmark in Europe.
The market for reliable government bonds is changing
However, a new member – the European Union (EU) – is now pushing into the exclusive club of debtors considered highly reliable. To cushion the economic impact of the Covid-19 pandemic and help member countries get back on their feet, the 27 EU member states put together a comprehensive aid package in July. The aim is to support the economy in this historic downturn, while at the same time pushing ahead with environmental and digital changes.
The EU's multi-billion euro reconstruction programme is designed to address the economic consequences of Covid-19 and ensure a sustainable and resilient economic recovery.
This time-limited reconstruction package is called "Next Generation EU" and has a budget of 750 billion euros. Under certain conditions, member States can call on this resource between 2021 and 2027 - with almost half in loans and slightly more than half in grants that do not have to be repaid. What makes this special is that the funds do not come from the regular EU budget, which individual member states finance with their contributions. Instead, a shadow budget has been established, for which the EU Commission may independently take on debt on behalf of the EU.[2] EU member states must reserve a certain amount in their national budgets for interest and repayments, which varies according to the strength of their economies. New EU-wide revenues, such as a plastics tax, a digital tax and money from emissions trading, can also be used
Favourable conditions for all EU countries
The largest section of the pandemic fund is the so-called Recovery and Resilience Facility with 672.5 billion euros.[3] Allocations from this should be based on member states‘ standard of living, size and unemployment rate. Southern and Eastern European countries should benefit most from the credit component. They will be able to raise funds indirectly on favourable terms obtained by the EU based on its high credit rating in the market.
The Reconstruction Fund has far-reaching implications. It means the EU will become a major top-rated Eurobond issuer. If member states use the fund to its full extent, the total volume of EU bonds will reach around 900 billion euros. This includes bonds issued in response to the euro crisis in 2010 and 2011, as well as 100 billion euros in labour market assistance from the "SURE" programme (Support to mitigate Unemployment Risks in an Emergency), which was adopted in 2020. Within Europe, only France, Italy, Germany and Spain have greater representation on the bond markets.[4]
EU bonds offer more favourable conditions
This large new debtor on the market also creates opportunities for investors. DWS experts expect that the EU bonds will have more attractive conditions than German government bonds to enable the EU to place this large volume of bonds on the market frictionlessly in the short time available. For ten-year bonds, the yield premium could amount to 0.1 to 0.2 percentage points. But as the EU’s borrowing will also encompass maturities of between three and 30 years, short-term and very long-term investors should also benefit from better conditions.
The EU will become the fifth largest issuer of Eurobonds after France, Italy, Germany and Spain.
Climate protection will play a special role in the Reconstruction Fund’s allocation. As a result, the EU could become the reference issuer for green bonds.
The pandemic fund should also give a boost to the green bond market. After all, 30 % of total spending is earmarked for climate-related projects.[5] In addition, countries must ensure that the expenditure of the reconstruction fund is in line with the EU's target of climate neutrality by 2050, the EU's climate targets for 2030 and the agreements of the Paris climate summit. By increasing its focus on green bonds, the European Union could become a reference issuer, giving new impetus to the sustainable bond market segment.
Reconstruction fund should strengthen the euro
The Reconstruction Fund’s final legal form is still pending - the EU Parliament and national parliaments will have input on certain aspects - but one thing is clear: European bond market weightings are likely to shift in coming years. And while this fund is time-limited, the hurdle preventing the EU from launching its own bond programmes should have fallen for future crises. It remains to be seen whether this will pave the way for a transfer and debt union. But the market's verdict is clear: the euro at least, which is an indicator of investor confidence in the eurozone, has appreciated significantly since the EU decision on the reconstruction fund.
