Markets are hungry for EU war bonds

BRUSSELS — The European Union is getting ready to tap markets for up to €150 billion to help finance military spending.  If it does, it shouldn’t have any trouble finding takers. 

European Commission President Ursula von der Leyen Tuesday announced plans to raise fresh funds that capitals could draw on from to boost their defenses as the United States pulls back from its long-standing security guarantees. 

The plan still needs approval from EU capitals — but if it goes ahead, the Commission would raise cash through bond auctions and pass on the money to member countries for defense outlays. They would then pay back the Commission for the funding. 

Ulrika Torell, senior portfolio manager at Alecta, a Swedish pension fund that manages 1.3 trillion kronor (€118 billion) in assets, said the fund would look closely at any new EU debt, having already bought it in the past.

Tony Persson, the fund’s head of fixed income, said: “If there is the political agreement to go ahead, there will be a functioning market for funding these initiatives. I’m quite sure about that.”

The EU’s biggest selling point as a borrower is its credit rating: Apart from Standard & Poor’s, all of the major ratings companies give it a AAA rating, deeming it effectively risk-free. Of the EU’s big economies, only Germany can match that.

“The worldwide supply of high-rated bonds has declined following credit rating downgrades,” said Elizabeth Palandeng, a spokesperson for APG, the investment arm of the Netherlands’ largest pension fund ABP. “Although there are still many fiscally strong issuers in Europe, the issuance of Eurobonds could be a useful addition,” she added.

EU joint borrowing is nothing new — but the pandemic marked a turning point in its use because the EU was able to borrow when a number of its member states, particularly highly indebted ones, would have been unable to by themselves. By the end of last year, the Commission had raised €330 billion worth of funds to help with the bloc’s recovery, plus another €100 billion for the SURE short-term job loss program.

To put that into perspective: Before then, the Commission was raising about €500 million a year on the markets. But since then, the EU’s executive arm has returned to the markets to tap another €50 billion to support Ukraine and €4 billion to help fund investments in the Western Balkans.

Before von der Leyen’s announcement, the Commission had said that it was planning on borrowing some €160 billion from the markets in 2025. That makes it the fifth-largest issuer in tradable debt denominated in euros this year. But it is still dwarfed by some national treasuries: Both France and Italy plan to issue more than €300 billion this year.

More fiscally conservative countries like Germany or Denmark — reluctant to backstop their more-indebted neighbors — have always wanted EU borrowing to be limited in volume and in scope. But should another, hefty round of joint borrowing materialize, that would be a big step toward the EU becoming a regular bond market participant akin to national governments. 

Common response

Von der Leyen’s suggestion is consistent with recommendations from former European Central Bank President Mario Draghi, who in a special 2024 competitiveness report promoted that common European challenges be financed by pooled resources.

“Security and defense is a European 'public good,'” said Alvise Lennkh-Yunus, head of sovereign and public sector debt at Scope Ratings, referring to the wording in Draghi’s report. He said that new joint borrowing would provide “clear confidence” and a “signalling effect.”

“I think it would be akin to when Europe faced the Covid shock,” he said. “You can argue endlessly what the impact of NextGenerationEU was on growth,” he added, referring to the coronavirus financial recovery instrument. “But there was a confidence impact, in that it calmed the market.”

For now, though, the EU as a borrower still faces obstacles to getting the best price for its debt. There is no place — at least not yet — for its bonds in the indices of sovereign debt that are tracked by funds that hold trillions of euros in assets. Inclusion in such indices would effectively force such funds to allocate a portion of their money toward EU-branded debt, making it cheaper to borrow.

In addition, there are few opportunities for investors to hedge their risk through futures and options contracts — in contrast to national government bond markets such as German Bunds and French OATs.

The Commission’s top budget official, Stéphanie Riso, has made no secret that she’d like joint European bonds to be better-established financial products. In a podcast appearance earlier this year, Riso said that in the past, investors have treated EU joint borrowing more like debt issued by government-backed agencies, such as the International Monetary Fund or the European Investment Bank, rather than normal government debt.

“The situation has changed,” Riso said. “This is what we are trying to explain to the market.”

But times are getting tough for borrowers around the world already under pressure from a flood of new government debt — not just in Europe, but from the U.S. to China. Joint debt would almost certainly be cheaper for some individual countries than its national equivalent; however, a larger supply of bonds will ultimately push borrowing costs higher, whoever the issuer. 

“Bonds were well-received by financial markets in the last couple of years when debt levels went up a lot,” pointed out Stefan Hofrichter, head of global economics and strategy at Allianz Global Investors. “But of course, I think the price will be that you will have to pay more, all else equal.” 

For others, though, there’s still plenty of capacity to take whatever comes.

“It’s been the financial crisis. It’s been a pandemic. It’s war — and still the money is flowing and the market is working,” said Alecta’s Persson. “I’m pretty impressed by the marketplace, actually. It can take a lot.”