Author: Alice Gledhill
Article: Original article
Publication date: Thursday, December 8, 2022
As the winter approaches, the European governments are frantically working on aid programs to protect their citizens from a rapid growth of energy prices. These are costly measures that expand costs by billions of euros, and the region’s financial needs have been record high for the last four years. The problem is that now the governments have to find new purchasers, while during the previous eight years the European Central Bank was ready to buy as many bonds as it was necessary.
According to analysts’ estimates, the situation will make the governments to sell new debt worth more than 500 billion euros — a record for this century. Meanwhile, bond investors affected by a surge in inflation aren’t willing to buy low-yielding securities.
As strategists say, even Germany and France aren’t immune to a possible jump in borrowing costs. BNP Paribas SA expects the benchmark German bond yields to increase by almost 1% by the end of the first quarter in 2023.
As for Italy, the most financially vulnerable European economy, the stakes are even higher. According to Citigroup analysts, a yield premium of almost 2.75 percentage might be required in the beginning of the next year aimed at incentivizing investors to buy Italian bonds. This level might easily provoke concerns and reactivate nervous speculation regarding the country’s ability to meet debt payments.
As it was said by Flavio Carpenzano, an investment director at Capital Group in London, borrowing costs will skyrocket in case European governments issue more debt to meet energy crisis and taking into consideration quantitative tightening, as the markets would doubt debt sustainability in such countries as Italy.
According to Citigroup estimates, net cash requirement of Italy is about to increase by 48 billion euros, which is the largest sum as a percentage of GDP after Portugal.
Global bond markets have already gone through a serious revaluation this year. At the end of 2021, the German 10-year yield was -0.18%. On December 7, it was 1.79%.
The question now is how much the investors will raise yields until they feel compensated enough for taking risks. Growing speculation that the ECB is about to slow down its tightening cycle has already caused a rally, while recession makes investors to abandon risky assets and move to relatively safe sovereign paper.
An increase in supply might also aid in easing the regular shortage of high-quality assets after the ECB spent years on buying bonds and reducing borrowing costs.
As it was stated by Annalisa Piazza, a fixed income research analyst at MFS Investment Management, it’s 100% correct that dramatic changes will be seen on the supply side, but it’s also possible that major changes might take place on the demand side. In her opinion, yields are interesting, and central banks around the world will get closer to ending their tightening cycles sooner or later.
But recent success may come to naught, considering the difficulties expected in the first half of 2023. The selloff in Britain proved how quick bond markets can go into turmoil, as vast plans of tax reducing under former Prime Minister Liz Truss finally caused the Bank of England to go into crisis-fighting mode.
There is also a possibility for the ECB to release its QT plan, which might turn out to be more aggressive than expected, although policymakers attempted to diffuse those fears. As it was said by Bundesbank President Joachim Nagel, the ECB’s balance-sheet reduction would be made “gradually”.
The risks related to high net supply of European government debt were the most often mentioned concern at a November meeting of the ECB’s bond market contact group. One of the organization’s members is Amundi SA, Europe-largest asset managing company. The company’s strategists noted the necessity to monitor the issuance closely.
Forecast: the EURJPY will decline