Government bond status would create structural demand for bloc’s capital markets borrowing While the European Union was dealt a blow earlier this year when both Intercontinental Exchange (ICE) and MSCI declined to add the EU to its government bond indices, there is hope that the EU will still achieve sovereign index inclusion sooner rather than later – …
Government bond status would create structural demand for bloc’s capital markets borrowing
While the European Union was dealt a blow earlier this year when both Intercontinental Exchange (ICE) and MSCI declined to add the EU to its government bond indices, there is hope that the EU will still achieve sovereign index inclusion sooner rather than later – perhaps as early as 2025. Such a move would have the single biggest impact to the EU’s bonds, making it attractive to global investors and increasing its demand, performance and liquidity.
‘The major game-changer will be the index inclusion,’ said an investor at the OMFIF-EU bonds summit in Singapore. ‘If the EU is included in an index, then our investments in EU bonds could be more structural rather than opportunistic’.
At present, the EU is by and large viewed by investors as a ‘spread product’. In other words, it is treated as a typical supranational issuer rather than a sovereign or a benchmark for European bonds. Most fixed income investors buy EU bonds on a relative value basis versus their peers or for a pick-up to other European government bonds.
However, inclusion to sovereign indices would completely invert this dynamic. ‘I do think that index inclusion really changes the structural demand for the asset class,’ said a second investor at the event. If the EU joins a government bond index, it will have a certain weighting of bonds held in that index so investors who link their portfolios to that index will also have the same exposure. Sovereign index inclusion will also open up the possibility to allow other investors who only buy government bonds to start investing in EU bonds.
Even without inclusion to sovereign indexes, some investors are already starting to treat the EU as a rates product, including bank treasuries who are beginning to place EU bonds in their European government bond portfolios. From a trading perspective, EU bonds are also performing well, with the bonds trading through France across most of the curve. However, this is due in part to the risks stemming from the recent French elections and budget.
The sheer size of the EU as the fifth largest issuer in Europe has turned it into a significant component in capital markets, behind only Germany, Italy, France and Spain.
‘When the NextGen (NGEU) bond programme was announced, the basic conclusion we had reached was that given the shortage of triple-A assets in the world, this would lead to the evolution of one more asset class that would become really relevant for global investors,’ said an investor. ‘In any asset class, if it crosses half a trillion in size, it starts to become a real part of an asset allocation strategy.’
The EU is not quite at a trillion in size yet, but it is moving in that direction with total outstanding EU bonds set to surpass €500bn by the end of 2024 and €1tn by the end of 2026. There is uncertainty about what lies beyond 2026 when the NGEU funding will end but the expectation is that the EU will remain a permanently large borrower in capital markets.
As well as continued large borrowing, the EU needs to continue to improve liquidity across the curve to convince market participants and investors that it deserves its place in sovereign indexes. A safe asset does not only need to have low credit risk, but it must also have strong liquidity. The upcoming launch of the EU’s repo facility will be an important development as well as a futures market and continued outreach and dialogue with global investors.
The OMFIF-EU bonds summit in Singapore formed the second part of a special series of events for investors to better understand how EU bonds are developing into a global benchmark and safe asset in capital markets. The first event took place in Dubai on 1 May, bringing together the European Commission with leading investors in the Middle East, while the second event took place on 10 September with leading investors in Asia.
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Please note that this article does not offer any instructions or suggestions regarding investment decisions. It is important for you to conduct your own research or seek professional advice from a qualified professional before conducting an investment decision.
