• Annamara Rimmer

Will Europe Let Sleeping Markets Lie?

The summer lull in markets that occurs during the late July – August period is an expected annual phenomenon for those working in the financial sector. Activity in both fixed income and corporate bond markets tends to quieten down, investor participation thins out, and as such, national treasuries in most developed countries tend to avoid issuing bonds during this time. Weaker demand means higher coupons are necessary to get sales away, and so in most cases, treasuries tend to wait until activity picks up once again in September.

However, despite the usual break in issuance calendars around this time, this year will mark an exception. Nations across Europe sold approximately €22 billion of bonds last week, with more likely to follow this coming week. Scarred by the coronavirus pandemic and the dire impact this had on many governments’ financial stances, Germany, France, Spain and Italy have been selling bonds in the August markets for the first time in over 10 years, marking the exceptional circumstances markets have been experiencing in this post-pandemic world.

Source: The Economics Review

So far this month there has been a similar pace of sales to the second half of July, but now this is occurring at a time where investors are receiving limited cash flows from maturing bonds, given the relative lack of sales at this time of year normally. This additional flood of bonds currently entering European fixed income markets has raised questions as to whether this could potentially halt the recent rally in European bond prices seen.

The start of August saw Italian yields reach their lowest point since March, and Germany’s reach their lowest since May. However, the excess supply hitting the markets, combined with the clear signalling of this exceptional move as to European governments' cash needs, could potentially see a reversal of the recent recovery that has been seen across European assets.

ING strategist Antoine Bouvet argues that concerns over coronavirus resurgences and the increasingly negative outlook for the global recovery, as well as the measures that might be required to limit the spread of the pandemic, are likely to suppress yields. Fears and uncertainty over the current Covid-19 outlook will drive investors into relatively safe assets, such as the European government debt that will be entering the market in this coming month. Mr Bouvet notes that “the news flow isn’t particularly encouraging”, and that, given the market’s close focus on the trajectory of the pandemic “it’s pretty hard to see fixed income markets repricing” whilst the outlook remains so bleak.

Goldman Sachs offers a more nuanced analysis, suggesting that Germany in particular will be able to avoid the reversal of the recent more positive movements, noting that “German bunds will still be the region’s benchmark for safety and stability”, even amongst Europe’s recent plans for joint debt sales. GS strategist George Cole wrote that despite the EU boasting top credit ratings, its joint debt will fall short of the “insurance value” against extreme risk prospects associated with German debt.

Whilst other European nations are still considered to be safe alternatives, analysts note that German bonds have been a favourite refuge for investors during episodes of heightened political risk and uncertainty. This offers them a stronger platform from which to avoid a bond market repricing than other European nations.

Source: Bloomberg

Despite this, the last week has seen the biggest weekly rise in German and French yields since June, and bond auctions from both nations equal in value to €13.5 billion are due in the coming week. Strategists at Citigroup estimate that France’s funding needs have increased by approximately €140 billion due to measures taken in response to the economic impact of the coronavirus, with Germany being in an even worse situation at €190 billion, highlighting the obvious trade-off European governments are currently facing.

European governments will be facing vast funding needs in 2021, given the likely expenses of measure required for the Covid-19 response, and so it makes sense for treasuries to be taking advantage of the current relatively benign market conditions. After the European Central Bank started their emergency debt-buying program a few weeks ago and the EU agreed to a €750 billion pandemic rescue fund, European nations saw a sharp fall in yields. This was particularly the case for nations such as Spain and Italy, since the pandemic rescue fund effectively signals fiscal transfers from the wealthy north of Europe to the southern nations.

Of the ‘Big Four’ Euro debt issuers, Italy has approximately €120 billion of their annual funding requirement left to raise this year, Germany has €100 billion, France €60 billion and Spain €30 billion, according to analysts from NatWest Markets. However, despite concerns that attempts to meet this funding needs might lead to increasin

g yields and halt the rally seen in European bond markets, the example of Italy shows that demand remains strong for European nations’ debt, despite the summer lull. Italy’s sale of 30-year bonds last week was done via regular auction, rather than by syndicates of banks, suggesting expectations of market demand were strong, although this could be attributed to the strong premium the yield offered over other European debt.

Source: Bloomberg

So, will the flurry of European bond sales in the summer lull reverse the recent positive trends seen in European fixed income markets? It’s difficult to say. Last week’s upturn in yields for both French and German bonds could suggest so. However, despite the summer lull, demand for these assets seems to be relatively strong, even for nations whose debt might be considered riskier than others. Combine this with relatively benign market conditions, and the sharp fall in yields seen after the EU’s announcement of the pandemic rescue fund, and it seems unlikely that there will be a noticeable reversal of the more recent positive trends seen in fixed income markets in the weeks to come.