William John Market Report 10-06-21
William John assess’s the European Commission's new debt issuance.
William John, Europe, bond, European Union, European Commission, monetary policy, capital markets

William John Market Report 10-06-21

William John Market Report 10-06-21

Category: Reports

In Europe, the European Commission is preparing to launch its biggest ever borrowing programme to help finance the European Union’s “NextGenerationEU” recovery plan from the impact of the COVID-19 pandemic.

The European Commission is looking to raise up to €800 billion by 2026 using a variety of debt financing strategies including the sale of: EU benchmark bonds of varying maturities, EU bills (less than one year maturity), ‘green’ bonds and ‘SURE’ bonds. The capital raised from the green bonds is going to be aimed at delivering environmentally green policies and investment across the Eurozone. It is expected that the issuance of green bonds will account for up to 30% of the entire fundraiser until 2026, approximately €250 billion. Furthermore, the Commission is looking to raise up to €100 billion in SURE bonds; social bonds of which the capital will be used to finance existing support for member states’ social security throughout the pandemic. According to the Commission, in 2020 the SURE support scheme supported between 25 and 30 million people.

The sustainable financing in particular ought to be commended, as the EU solidifies itself as a global pioneer in environmental and social economic development. The Commission plans to use the capital raised as part of its NextGenerationEU project to provide €672.5 billion as a Recovery and Resilience Facility (RRF) broken down into €312.5 billion in grants to member states and €360 billion in loans to member states, amongst smaller commitments to other EU initiatives including “InvestEU” receiving €5.6 billion and “ReactEU” receiving €47.5 billion.

However, the impact of borrowing costs (proxy measured as bond yield) on the bonds could have a big impact on whether member states decide to take up the Commissions offer on loans. Illustrating the cost of borrowing on sovereign debt for a basket of European member states and the European Union:

Source: William John Analytics, worldgovernmentbonds.com, European Central Bank Statistics

Yields represent the rate of return an investor can expect to receive for purchasing a publicly traded bond at its given market price. As bond prices fluctuate over time (but have to pay a fixed coupon as part of the debenture) they are inversely proportional to a bonds yield i.e., if an investor purchases a bond at a discount (below par value) it will have a higher yield given a set coupon and vice versa if the investor purchases a bond at a premium (above par value). Therefore, the higher the yield is, the more costly it is for the issuer to pay the debt back relative to the price of the bond.

Observing the graph, any member state with a more positive yield than the EU is inclined to request loans from the facility at the EU’s cost of borrowing because it is cheaper to do so than issuing their own sovereign debt given the European Union’s credit rating of Aaa (Moody’s). Any member state with a less positive yield is inclined to do the opposite. 

As member states can request loans up to August 2023, how European sovereign debt yields fluctuate over time is likely to shape European bond markets for the foreseeable future as more or less member states try to access cheaper financing through the EU’s “NextGenerationEU” facility – this could provoke adjustments of its programme or even the Union’s monetary policy as investors try to anticipate bond price movements in the medium- and long-term future until 2026. 

Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.