WisdomTree: Is now the time for Eurobonds?

April 20, 2020

By Lidia Treiber, Director, Research

As the impact of Covid-19 lockdowns begin to more deeply unveil the economic impact that these severe measures have had on different European countries, the cost of funding has started to rise sharply for hard hit countries such as Italy and Spain. The spread of peripheral sovereign bonds over German sovereign bonds has begun to widen as investors become concerned about the rising debt to gross domestic product (GDP) levels for countries with already weaker fundamentals.

The thought of a V-shaped recovery, one which begins with a steep decline, but hits its bottom and recovers quickly, is starting to dissipate as countries are expected to gradually lift lockdown rules to avoid a relapse in Covid-19 cases as has been the recent case in the Chinese region of Harbin. Outside of the significant stimulus measures already seen in Europe, the US and elsewhere, the resurgence of the possibility of Eurobonds has landed on the discussion table again. On 25th March, nine eurozone countries - Belgium, France, Italy, Luxembourg, Spain, Portugal, Greece, Slovenia and Ireland - advocated in a formal letter to the President of the EU Council, Charles Michel, for a common debt instrument to mitigate the damage caused by the coronavirus crisis. The notion of Eurobonds was initiated by the Barroso European Commission back in 2011 during the 2009-2012 European Sovereign debt crisis and aimed to launch government bonds issued by the European Union.

While a Eurobond type instrument was turned down during the European debt crisis nearly a decade ago, the letter goes on to support such an instrument during a crisis by stating: “we are all facing a symmetric external shock, for which no country bears responsibility, but whose negative consequences are endured by all…and we are collectively accountable for an effective and united European response…this common debt instrument should have sufficient size and long maturity to be fully efficient and avoid roll-over risks now as in the future.” As was the case during the last crisis, Germany and the Netherlands are strong opponents of such an instrument. They fear that Eurobonds would allow highly indebted EU states access to cheaper credit and reduce the accountability of individual states as the penalty of high debt costs would be mitigated.

If we recall back to the height of the European debt crisis[1], the 10 year Italian government debt (BTPs) was yielding 7.24%, offering a spread of 4.91% over similar maturity German government debt (Bund).  In comparison the spread of 10 year Italian BTPs over German Bunds is currently[2] around 2.27%. There is still room before the alarm bells will ring for change. If Eurobonds do not come to fruition during the current crisis, we may see rising tensions among EU states as countries such as Italy, Greece and Spain continue to be penalised by bond investors. During 2012, the European Central Bank also indicated that they would do “whatever it takes” and the Eurobond push eventual lost ground. While this crisis has already turned out to be more severe than the last due to widespread economic lockdowns being imposed globally, the opposition for such an instrument remains strong. The European Council members are set to have a video conference this week[3] and this will likely be a hot topic of discussion among members. Could its fate be different this time around?

Unless otherwise stated, the data source was Bloomberg

[1] 29th November 2011

[2]  on 19th April 2020

[3] on 23rd April 2020