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Europe needs 500 billion euros in cash after losing top bond buyers


(Bloomberg) — As winter approaches, governments across Europe have been scrambling to draft aid programs to protect their citizens from rising energy costs caused by Vladimir’s invasion of Ukraine. Putin. There are electricity price caps in France, gas discounts in Italy, and heating bill subsidies in Germany.

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These measures cost a lot of money, added hundreds of billions of euros and increased the region’s financial needs far beyond historical standards for the fourth year in a row. The problem with it all is that unlike the past eight years, when the European Central Bank happily printed money and bought as many bonds as needed, governments will have to find new donors.

In fact, the ECB’s pivot will be so quick that analysts estimate it will force governments in the region to sell more new debt in the bond markets next year – up to 500 billion euros on an annual basis. net worth – more than at any time in this century. And bond investors, threatened by the same rising inflation that the ECB is trying to contain, are not in the mood to tolerate financial generosity right now. As Liz Truss discovered, they will give an exact price.

Even regional powers such as Germany and France won’t escape soaring borrowing costs, strategists say. BNP Paribas SA sees benchmark German bond yields rise by almost 1 percentage point at the end of the first quarter.

And for Italy, the European Union’s most financially vulnerable major economy, the risks are much higher. Citigroup analysts estimate that by early next year, the yield spread will be nearly 2.75 percentage points higher than standard packages to entice investors to buy Italian bonds. That’s a level that could raise alarm bells in Brussels and rekindle worries that have been rising and falling for years about the country’s ability to pay its long-term debt.

“If you move to an environment where European governments are issuing more debt in the face of the energy crisis and above all tightening regulation,” said Flavio Carpenzano, chief investment officer at Capital Group in London. volume, borrowing costs will increase massively”. “Markets will start to question the sustainability of debt in countries like Italy.”

Europe’s energy tab passes 700 billion euros as winter arrives

Barclays Bank Plc forecasts net issuance of European government bonds will grow to nearly 500 billion euros by 2023, a record high. That number takes into account the need for additional funding should the recession become more severe, and also takes into account other sources of funding outside of the bond market. The net amount could increase by 100 billion euros if the ECB begins to restrict reinvestment, the so-called quantitative tightening.

In Germany, at the heart of the region’s energy crisis due to its dependence on Russia, measures include support to pay heating bills, subsidies and gas discounts. France has implemented a ceiling on electricity and gas prices. S&P Global Ratings recently changed its outlook for the country from stable to negative, pointing to fiscal policy as “very accommodative”.

According to Citigroup estimates, Italy’s net cash demand – which affects total supply, redemptions, free-floating coupons and central bank cash flows – will increase by 48 billion euros. , the largest as a percentage of GDP after Portugal.

Fashion for Italian bonds could become a fad next year

Ario Emami Nejad, fund manager at Fidelity International, said: “Even if Italy follows the European line, it will issue a lot. “BTP is unlikely to sustainably trade near 150 basis points, as you ultimately have to value all the tail risks of quantitative tightening and issuance with limited upside.”

Attractive profit

The global fixed income markets experienced a major revaluation in a bad year for bonds. At the end of 2021, the German 10-year yield is -0.18%. On December 7, it was 1.79%.

The ECB is not alone in shifting to extremely loose monetary policy. The Fed began quantitative tightening six months ago, shrinking its balance sheet by about $330 billion as of November 30, while the Bank of England is aggressively selling gilts on the market.

The question now is how much more investors will push the yield until they feel well compensated. Growing speculations that the ECB will begin to ease its tightening cycle has fueled a rally, while a slowing economy will lure investors away from riskier assets and into a rally. relative safety of the title.

The larger supply will also help alleviate a chronic shortage of high-quality assets after the ECB spent years sucking up bonds to reduce borrowing costs as it transitions from crisis to crisis. another panic.

“It is 100 per cent true that we will see a big shift on the supply side – but at the same time, we could also see a shift in supply,” said Annalisa Piazza, fixed income research analyst at MFS Investment. big change on the demand side”. Management. “Yields are very interesting and sooner or later, central banks globally will get closer to the end of the tightening cycle.”

Common interest

But recent gains may wane due to the challenges ahead in the first half of 2023, especially since many governments have a tradition of pre-release.

The UK’s recent sell-off shows how quickly bond markets can catch up as extensive tax cuts under former Prime Minister Liz Truss finally forced the Bank of England to move. to anti-crisis mode.

There is also the possibility of the ECB announcing a more aggressive QT plan than expected, although policymakers have tried to assuage those concerns. Bundesbank President Joachim Nagel said in November that the reduction of the ECB’s balance sheet would happen “gradually”.

ECB seizes opportunity for QT should not rely on market calm

Risks related to a high net supply of European government debt were the concern most frequently raised at the November meeting of the ECB’s bond market exposure team. One member of that group is Amundi SA, Europe’s largest asset manager, where strategists wrote in a recent report that sovereign issuance should be closely monitored.

“There will be more bonds in 2023 like more bonds without quantitative easing,” said Giles Gale, head of European interest rate strategy at NatWest Markets.

–With support from Sujata Rao.

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