Blain’s Morning Porridge – 14th April 2021 – Yoorp’s Big Bond Bonanza
“Bond markets can bully anyone…”
This morning: Europe’s plans for a €1 trillion bond programme will create a single US Treasury scale market, but who agreed it? The big risks are the imperfect non-democracy’s funding programme will magnify political volatility, while empowering bad political deals.
It’s a bit topsy-turvy in the discombobulated Blain household this morning. Not only have we just moved into a second rental flat while our house is finished, but yesterday Deejay, an impossibly cute Cockerpoo puppy with a jet-black coat and white tummy, joined the family. He’s a dote. For the first time in years I didn’t start the day with a perambulation around the digital pages of the FT….
Back to markets…
After I’d finally got the day together, what did catch my eye on Bloomberg is the EU’s plans to rival the US Treasury market through its long-term recovery plan for Europe. Over the next five years The European Commission intends to issue €1 trillion of European Union debt to finance Europe’s recovery from the pandemic. Naturally, most of that issuance will be made more palatable and attractive by calling the new EU financings “Green Bonds” – defined as green by a framework the EU itself is writing. Ahem…
Now some folk might be labouring under the impression the European Union is a customs union that got around to currency union and asking why it, and not the sovereign states of Europe themselves, are financing recovery? After all, there are no treaties to say Brussels is responsible for the financing of Europe, or that it should set fiscal plans and objectives.
Hah. You haven’t been paying attention then…..
Perhaps the Euro is “democratised finance”, (as a bogus “Crypto-barker” might call it), in that it’s a monetary union agreed by, and overseen by every member nation in the ECB. But Central Banks are not democracies – if every member nation got to determine policy, it would be chaos. Which is why the ECB is presided over by a former French politician, Christine Lagarde, to ensure stuff gets done, that stuff is the right stuff, and the membership falls into line. Being head of the ECB is not your typical central banker gig.
Meanwhile, the European Commission – another not-a-democracy – will allocate the recovery funds and is run by a former German Politician, Ursula von der Leyen, a lady who has been having such success with the European’s union vaccination programme. Do you discern a theme?
The key thing about the EU bond programme – which has been quietly taking shape for years – will be its eventual scale and its status as, effectively, the European Sovereign Debt market.
If you want bond exposure to Europe – what would you buy? Naturally the lowest risk is the incredibly tight and undersupplied Bund market for German debt? Or maybe the slightly more whoosh French OAT market? Or for a bit of a dare, Italy or France? These are all relatively small, insular markets, best used to play themes and hunches in terms of their relative spreads and, critically, how much more the ECB is prepared to spend in terms of QE buying them on the open market.
But, but and but again…. none of these European national bond markets are truly sovereign debt. All the member nations of the European Union’s Euro gave up their financial sovereignty when the joined the Euro. In effect the member states are merely sovereign credits – as they don’t hold the keys to the Euro printing presses, they rely on the whim of the ECB to allow them to borrow. The ECB does this by setting rules – which all the member states struggle with – which constrain them from printing money to reflate their own economies. Such constrain breeds political unrest as we saw in Greece and Italy, and now elsewhere.
Its size makes the new EC programme look very attractive as it lays out its alternative recovery programme and financing plans for both “Green” and “Social” bond flavours. As it effectively controls the ECB, it has monetary sovereignty. The EU has now clearly signposted its objective – to replace all the national bond markets, and compete in scale terms with the US Treasury bond market (the most liquid and largest market). The EU is demonstrating it bonds are therefore a much better bet than Bunds, Oats, BTPs or Bonos issued by member nations.
Except… there is no such thing as a riskless or free lunch.
The big, the massive risk, to EC bonds is politics. The Euro only exists on the willingness of the member states to stick with it, just as its theoretically possible – although in practice very difficult – to exit the EC. By combining all the national markets of Europe, it would become even less likely. The mutualisation of Europe’s debt is therefore a political objective for the Eurocrats in Bruxelles. But mutualisation and Brussels control will raise the level of dissent… it’s a difficult square to circle.
The big risk buying EC debt is a rupture in the political process – nations pushing back politically over the mutualisation of their debt. We know that is a massive concern for the German constitutional courts, which have pointed out the lack of any treaty signed by Germany to agree to such a burden on the German tax-payer. It’s also a cornerstone for pushback from the far-right across France and Northern Europe.
Even worse would be European nations gaming the EC debt programmes – refusing to sign or agree on vital European matters unless they were guaranteed specific pork-barrel funding programme finance from Brussels, which might just end up in shady places. Heaven forbid anything Europe finances ends up in less than salubrious places….
At this point it might be interesting to look at an example of what happens when politics impacts markets. I thought about the unpleasantness in the Americas between the Union and Confederacy in the 186os. Surprisingly even the domestic yield on Confederate bonds remained relatively low until the end – driven by patriotic buying. What is fascinating is that US (Union) government debt rose from $77mm when Lincoln took office in 1861 to over $3.4 bln in 1865 – largely financed by government bond sales pushed to investors on the basis it was the patriotic thing to do to preserve the Union.
Somehow, I don’t see much appetite across Europe for saving Brussels on the same patriotic basis? I would be very interested in reader views, especially from Europe, on the new European bond market. Please post them on the Website.
(Also worth noting – The EU will be launching its new bonds at an interesting moment with a long-term bear bond market on the horizon. With y’day’s US consumer price inflation at 2.6%, it’s a clear sign of a developing inflationary bias. That’s hardly a surprise as the global economy prepares for the pandemic reopening, global supply chains remain taught, and fiscal stimulus plans abound.)
Meanwhile… Seaspiracy..
My article last week on the Netflix documentary Seaspiracy has generated a very large postbag. Most respondents have agreed with my take it was a very flawed film, but it achieved its point and has shocked us into questioning how unsubstantiated definitions of sustainability and greenwashing could impact our attempts to achieve environmental balance. I got copied into some email chains involving ocean campaigners who were castigated in the movie – and there are some very angry people out there who rightly feel betrayed.
Fake news works both ways – as one campaigner wrote: “Netflix is in business to make money and documentaries have to be sensational or outrageous to attract an audience, and telling half-truths or outright lies and manipulating facts appears to be completely acceptable these days.”
I get the sense there is another film to be made; how vegan extremists have been able to present their arguments as calm and rational, but none of that should detract from the very real issues about ocean and fishing degradation.
The key is to keep an open mind – and I would definitely recommend this article as a counter to Seaspiracy: “What Netflix’s Seaspiracy gets wrong about fishing, explained by a marine biologist”.
5 Things to Read This Morning
Torygraph – Bull or Bear? The Dangers of the stock market gamble
FT – Grab is lunging for the top of the SPAC market
FT – China’s digital currency is a threat to dollar dominance
WSJ – Banks, after bracing for disaster, are ready for a boom
BBerg – Credit Suisse Problems Go Right to the Top
Out of time, and back to the day job
Bill Blain
Shard Capital
2 good choices: Get out of the EU ( as GB did), or get in. Muddle through is useless. And if the north pays for the south, they will finally have a say in how (not) to spend it.
PS I became a huge fan of the morningporridge.
Always good to have fans! Make sure you subscribe!
Europe is not for the UK. But it will work. Give it time.
Bill,
You make no mention of the German Constitutional Court and it’s recent decision to at least temporarily prevent Frau Doktor Merkel signing up for their share of the €750 billion recovery.
It seems that there can be no other words to describe the performance of the Euro Project, other than pure abject failure. But remember that Jean Monnet and the other architects of the EU, were warned from the outset that without political union, for which there was negligible support, there would be dire consequences should a single currency be adopted. Rather than stopping them in their tracks, they actually found reasons to continue on the basis that the inevitable tensions and pressures within an incomplete monetary union would, through a process they called “falling forward”, force the member states toward deeper political cooperation eventually leading to a federal state.
No doubt the high priests in Brussels will grab the opportunity of the EU’s poor overall performance during the COVID epidemic to push further forward towards eventual a federal Europe. This may be the last possible opportunity for the constitutional court to slam on the brakes.
I did! 🙂
Bill,
It seems that there can be no other words to describe the performance of the Euro Project, other than pure abject failure. But remember that Jean Monnet and the other architects of the EU, were warned from the outset that without political union, for which there was negligible support, there would be dire consequences should a single currency be adopted. Rather than stopping them in their tracks, they actually found reasons to continue on the basis that the inevitable tensions and pressures within an incomplete monetary union would, through a process they called “falling forward”, force the member states toward deeper political cooperation eventually leading to a federal state.
No doubt the high priests in Brussels will grab the opportunity of the EU’s poor overall performance during the COVID epidemic to push further forward towards eventual a federal Europe. This may be the last possible opportunity for the German Constitutional Court to slam on the brakes.
I disagree in parts Alistair
The EU has achieved much. It is maybe evolving towards political union – you can’t deny European yoof are much happier being Europeans than previous generations. THere is a sense of European identify that is new and good. However, the inequalities between nations are being cruelly exposed by the way the Euro has worked – consequences! It allows dissenters to point to Europe and Euro as cause of their troubles – thus making eventual political/federal union more difficult.
The issues at the root of the troubles are the continuations of all the old European issues: nations come before Europe. It has not helped that a dire bureaucracy – i prefer the Russian Nomenklatura – has developed to police standards.
I don’t think Europe self-destructs, but it will remain bureaucratic and static in the next period of growth and recovery.
…and some argue there’s no value prop for Bitcoin? Smell the Roses, please!
The value of Bitcoin, Tulips, Odd-Socks and Horse Manure is whatever the market determines them to be….
On BC – its crypto 101. You wouldn’t let a first year med student lose on a population with as little skill as BC has utility. Crypto is evolving.
Bill –
I agree with the market opportunity created by the impending EC bond issue, but …
Given the increasing political & ideological disharmony between EU member states I am concerned the ongoing debt management will be rather challenging and bears significant potential for political backlashes within the major contributing countries.
The big challenge for the ambitious EUR 750bn ‘rescue plan’ will be oversight and cost control on spending. Given Mrs. v.d. Leyen’s track record in both, Berlin and Brussels, my expectations are somewhat muted …
German elections in fall of this year are approaching fast and it is unclear whether the CDU/CSU Conservatives will get another mandate to form the next government. If a coalition led by the Greens will take charge, the ideological fallout especially with CEE governments in Warsaw and Budapest is likely to accelerate. Also, it remains to be seen how Mr. Macron will be able to weather a more moderated political assault of Le Pen’s ‘National Rally’ at the upcoming French elections.
Btw – the grumbles within the German political system are even more nuanced. Whenever the German Constitutional Court wants to prevent the German President to hold off on signing new legislation, they politely ask through the usual back channels.
However, when it came to the law allowing German backing for the 750bn program and related bond issue, the Constitutional Court publicly forbade the signing.
This implies a) internal back channels didn’t work & b) there is significant friction and disagreement on a national level. Both are rather unprecedented in a German context.