Central Banks Pile Into Europe's Common Debt

By Anna Hirtenstein

Central banks were among the biggest buyers of European common debt this week, signaling growing trust that the euro will hold its own through the pandemic.

The European Commission -- the European Union's executive arm -- issued its first wave of common debt to finance its coronavirus-relief programs Tuesday. It raised EUR17 billion, equivalent to $20 billion, from the sale of 10-year and 20-year bonds.

Close to 40% of the benchmark 10-year bond was snapped up by central banks' reserve managers, which is about double the average for prior European bonds, according to research from Deutsche Bank. They also bought 13% of the 20-year bond.

"Demand signals a vote of confidence on the euro as a reserve asset," said George Saravelos, global head of FX research at Deutsche Bank.

This year has been a significant turning point for the EU's financial cohesion. The region is perceived to have overcome some historical divides that had held back collective action, particularly after the approval of an economic recovery fund that will include both grants and loans for the countries hardest-hit by the pandemic. The bloc is financing its coronavirus-relief programs with common debt such as Tuesday's issuance, spreading the cost of the pandemic across its member states.

This has been a key contributor to the recent rise of the euro, according to Vasileios Gkionakis, head of foreign-exchange strategy at Lombard Odier. The common currency has gained 1.1% against the dollar this month and 5.7% over the year.

Mr. Gkionakis expects the currency to strengthen further.

"Investors are getting positive signals coming out of Europe, including this step toward mutual debt issuance," he said. "That restoration of faith and confidence is likely to attract more demand from reserve managers."

The pricing of the bonds is also likely to lure investors, said James Athey, an investment manager at Aberdeen Standard Investments.

"Compared to France, it's more highly rated but also has a higher yield. That's the Holy Grail," Mr. Athey said. The higher yield is because the market is new and relatively small, making it harder to buy and sell the bonds, but that is unlikely to be a concern for reserve managers because they tend to hold assets for a long time, he said.

The European Commission is set to issue up to another EUR833 billion of common bonds to finance its coronavirus-relief programs in the coming years. This wave of issuance is likely to increase investor access to European government debt and push up the flows of capital into the region, further boosting the euro, according to Kit Juckes, a macro strategist at Société Générale.

This would mark a turnaround for the European government bond market. The ECB has bought so many assets as part of its monetary stimulus that they have been in short supply for years. This year, the net supply of government bonds is expected to be negative, according to projections from UBS. This has dampened the ability of foreign investors to buy euro-denominated assets.

The incoming wave of EU bond issuance is likely to change this and allow central banks to load up on euros if they choose.

"If I'm managing currency reserves and I think the euro might strengthen, I would buy more euros," Mr. Juckes said. Also "a pan-European AAA-rated piece of paper is pretty attractive."

Write to Anna Hirtenstein at [e-mail]

(END) Dow Jones Newswires

10-23-20 1106ET