The European Union is certainly making history. Earlier this month, its Commission announced that it would issue so-called SURE (abbreviated for The Temporary Support to Mitigate Unemployment Risk in an Emergency) bonds of up to 100 billion Euros as social bonds. This is the part of the joint and several debt that member states have committed to raise in order to fight the effects of the health crisis that has crippled particularly the Continent’s periphery.
There is quite a bit of fine print to the observed here, as nothing is ever straight forward when it comes to EU finances and structures. This social bond framework is formally backed by both the EU budget and 25 billion of member state guarantees, which I guess people could view as the equity portion. One thing is fair to say, I reckon… We have probably never come closer to the concept of debt mutualisation across European countries than this.
The program got kickstarted on Tuesday, when 17 billion of 10- and 20-year paper were issued, and is designed to become one of the largest European borrowing schemes. All eyes were obviously on the pricing of the tranches and how that would compare to the sovereign debt of individual countries. It was clear from the outset that the new bonds would have to command a premium to French OATs and German Bonds to make the inaugural move a success.
A flabbergasting 14-times oversubscription easily took care of that, and the 10-year tranche eventually got priced at a premium of around 10bp to the OATs and 35-40bp to Bunds. While the lead managers managed to squeeze a low double-digit positive yield from the 20-year tranche, the 10-year ended up at a yield of -1/4 point and joined the evermore increasing balance of negatively yielding fixed income instruments denominated in Euros.
Every major investment account across the Continent and beyond was part of the order book. It should not really come as a surprise, as 1. every central bank in the world with foreign reserves in Euros is finally presented with an investable option that reflects a comprehensive eurozone exposure, and 2. any and every premium to Bunds and OATs is being seen as a god-sent by captive long-dated investors such as pension funds and life companies, despite the negative yield.
The community is calling this historical and a chance to legitimise the Euro as a true reserve currency. And to be sure, the making of a large and liquid joint bond market is, in fact, a key ingredient for this purpose. But we have to be serious here. The SURE program would have never come into existence, had the health crisis not forced Germanic Europe’s hands. SURE specifies contributions as temporary support, and no one can tell how much further the experiment will go.
And then there is obviously the issue of moral hazard. We should all remind ourselves what had led to the eurocrisis in 2010-2012. Upon the inception of the monetary union, investors successfully bet on a convergence of government rates across jurisdictions, and we know how that ended. Greece was the most prominent poster boy of raising too much debt at unjustifiably low cost, spending it irresponsibly, and tweaking public accounting – until the house of cards came crashing down and painful debt restructurings ensued.
If I look at Italy’s government bond market these days, things resonate with the past. In anticipation of some form of support if not a bail-out in the wake of Covid the 10-year rates have halved since June, to an incredible 74bp, and we are witnessing a similar yield conversion as we did in the early 2000s. But what’s the basis for that other than the perceived advent of debt mutualisation? It is certainly not a convergence of economic performance between Italy and Germany.
Meanwhile, the Banca d’Italia kindly let us know that the country’s government debt mountain climbed by a whopping 115 billion to an obviously new record of 2.58 trillion Euros in August. Ever since the currency union commenced 20 years ago, Italy has basically doubled its debt load. The debt-to-GDP ratio is clearly pushing the 160% mark now, and we are finding ourselves in Greece’s territory of 10 years ago. However, no one can push Rome around as they did Athens.
What a difference a SURE bond can make. It seems we will further close ranks in Europe, something we have witnessed numerous times on occasions of crises, and investors will readily play along… until they come to the realisation that there is nothing like a SURE thing, and it derails again into a game of musical chairs.
