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EU prepares for take-off with €800bn bond issuance scheme

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The EU is preparing to wade into increasingly choppy bond markets as it embarks on the European Commission’s biggest-ever borrowing programme.

Debt managers at the commission have held calls with banks and investors this week ahead of the sale of the first bond backing its €800bn NextGenerationEU recovery fund — the groundbreaking vehicle agreed last summer to fund the region’s pandemic response with debt backed jointly by member states. 

Bankers are expecting the deal to price next week, raising more than €10bn from a new 10-year bond.

The sale is the latest milestone in the transformation of the EU itself into one of Europe’s biggest bond issuers, and a prelude to regular debt auctions starting in September as Brussels aims to raise €80bn for the recovery fund before the end of the year. 

It comes at a time when markets have been buffeted by rising inflation, and investors are speculating about when the European Central Bank will begin to wind down its €1.85tn emergency bond-buying programme.

“They’re starting this process in a rising rate environment; it’s a different world to last year,” said Antoine Bouvet, a senior interest rates strategist at ING. “I don’t think anyone doubts the EU’s ability to sell this debt, but they’ll be paying out a bit more to do it.”

Line chart of 10-year bond yields (%) showing The EU's borrowing costs have climbed

Brussels’ borrowing costs have risen since October when the first bond to fund the EU’s Sure programme — a smaller €100bn scheme to support jobs during the pandemic — met with record-breaking demand. Since then, the yield on 10-year EU bonds has risen 0.3 percentage points to just above zero, echoing similar advances across eurozone debt markets.

“Thanks to the EU’s high credit rating, the Commission will be able to borrow on advantageous conditions,” the European Commission said. “The Commission will then pass the benefit on to the EU Member States directly when providing them loans or to the Union budget in the form of low interest rate payments on borrowings to finance recovery spending.”

The ECB is widely expected to continue with €80bn a month of net bond purchases at its latest policy meeting on Thursday. Even so, the topic of a reduction in the pace of buying is likely to return later in the year as economies rebound from the pandemic. 

Markets got a taste last month of what that might look like, as speculation of a reduction in support hit bond prices, pushing yields to their highest level in a year. During that period, the most recent EU debt sale drew weaker demand from investors than earlier issues. Yields have since fallen back, after ECB boss Christine Lagarde said it was “far too early” to discuss tapering.

Brussels has already made strides towards becoming an established force in bond markets. Prior to the launch of Sure, it had just €50bn in outstanding bonds, a figure dwarfed by the big national debt piles, like Germany at about €1.5tn, and Italy at €2.2tn. But since October the commission has raised €90bn of debt under Sure, in seven transactions. 

The €80bn of NextGenerationEU debt the EU plans to issue in the second half of the year will make it the biggest net borrower in the euro area over that period. The commission aims to raise up to €800bn between now and the end of 2026 for the programme, with about €407bn available for grants to member states and €386bn for loans. Borrowing volumes will average €150bn a year. About 30 per cent of the bonds is ultimately expected to be earmarked as green bonds to bolster sustainable finance. 

Line chart of Monthly turnover (Jan 2020 average = 100) showing Trading in EU bonds has surged

Alongside preparations for borrowing, the commission has in recent weeks been working through member states’ detailed recovery and resilience plans, in which they pitch for the EU funding and set out investments and reforms. These then need to be signed off by member states. 

Trading of EU bonds in the secondary market has increased as much as 10 times since last summer, transforming a relatively sleepy backwater more akin to the debt of other supranational bodies such as the European Investment Bank or the European Stability Mechanism into a market to rival Italy or France, figures from bond trading platform Tradeweb show.

The EU’s bonds have recovered more slowly from the recent price drop than most eurozone debt, a sign that the coming deluge of issuance is weighing on prices, according to Michael Leister, head of interest rates strategy at Commerzbank. Uncertainty over the path of ECB policy would give investors “more bargaining power” to demand extra yield at sales of new debt, he added. 

“We will buy [the new EU bonds], especially if they offer a decent premium over Germany,” said Paul Brain, head of fixed income at Newton Investment Management. “But the market has a lot of issuance to digest, not just joint issuance through the recovery fund but from individual governments.”

Thanks to its triple A credit rating, the EU still enjoys lower funding costs than the vast majority of member states, with the exception of Germany — the euro area’s ultimate market haven. 

But any shift in the EU’s funding cost relative to member states could be significant, said Leister. States including France and Belgium, whose long-term funding costs were slightly above those of the EU, could be less inclined to take loans from the recovery fund if the gap narrowed. 

Countries like Spain, meanwhile, could be more inclined to take up loans if their own borrowing premium rises faster than the EU’s. As things stand seven EU member states have requested loans under the programme, but the commission will remain open to loan requests up to August 2023. 

“It boils down to the relative cost, and even a small market move changes that quite a lot when rates are this low everywhere,” Leister said.



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Analysis

Ronaldo’s Coke moment signals shifting balance of power in sport

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Cristiano Ronaldo’s rejection of strategically placed Coca-Cola bottles at a press conference at the Euro 2020 football championships this week has left sponsors and tournament organisers scrambling to limit the damage on endorsement deals.

The gesture by the Portugal star, who on Monday picked up a bottle of water saying “Agua . . . no Coca-Cola”, was mimicked by other players including Italian midfielder Manuel Locatelli, while France’s Paul Pogba removed a Heineken bottle during media commitments later in the week.

Uefa, European football’s governing body, has contacted national federations to tell teams to avoid actions that could affect tournament sponsors, each of which have paid about $30m to endorse the competition.

But there are no specific rules to police how players must discuss the corporate partners for the Euros. And there has been no reprimand of Ronaldo who, according to one senior European football executive “is so powerful, no one can tell him what to do”. 

That admission is a reflection of the changing power balance at the top of the world’s biggest sports. Highly paid athletes appear more willing to challenge the media and marketing deals struck by the leagues and competitions they play in, if those financial imperatives clash with their own carefully tailored corporate image or sincerely-held beliefs. 

Ronaldo’s viral moment led some media outlets to claim that the incident wiped billions from the market value of the US drinks company. But Coca-Cola’s shares slipped about 1 per cent in morning trade before the press conference even began, a drop that accounts for most of the day’s losses. 

The stock has fallen steadily over the days since, though it managed to recover some ground on Thursday, closing higher for the day at $54.95 .

While Locatelli appeared to be joking by following Ronaldo’s lead, Pogba is a practising Muslim who on Tuesday removed a Heineken bottle placed in front of him at a post-match press conference, though the item was from the Dutch brewers’ line of alcohol-free beers. 

Muslim athletes have cited their religious beliefs for declining to take part in marketing activities with alcoholic drinks brands and gambling groups. “We fully respect everyone’s decision when it comes to their beverage of choice,” said Heineken. 

Last month, Japanese tennis player Naomi Osaka pulled out of the French Open tournament rather than take part in compulsory press conferences, suggesting they were damaging to her mental health. Post-match media access to players is considered key to the value of television deals for tournaments. 

Ronaldo is known for sharing pictures of his intense training regime on Instagram, where he has roughly 300m followers, and has expressed disapproval at his children imbibing fizzy drinks.

Many of his sponsorship deals fit this image of healthy living, such as with sportswear group Nike and nutrition company Herballife — endorsements that have helped him become the first footballer to earn $1bn over his career, according to Forbes. 

However, the player has also previously appeared in adverts for Coca-Cola and Kentucky Fried Chicken.

“I have to say there was a collective raise of eyebrows in the industry about Ronaldo, who has a long record of brand endorsements, some of which don’t fit with his apparent approach to life,” said Tim Crow, a sports marketing expert. “There was a lot of cynicism.”

Ricardo Fort, a former Coca-Cola executive who previously spent nearly two decades managing the company’s sports partnerships, said the incident was an example of rights infringement, with the sponsor potentially entitled to damages. 

Japanese tennis player Naomi Osaka pulled out of the French Open rather than take part in compulsory press conferences © Martin Bureau/AFP via Getty

“Sometimes [rights infringement] can come from a competitor ambushing the event, sometimes it can come from the organisers, sometimes it’s a player,” he said. “In general this is a big distraction for the event and the companies which invested a lot.” 

Though using bottles as product placement is a contractual obligation of the deals that Uefa has struck with Coca-Cola and Heineken, neither brand has demanded compensation, according to a person close to the discussions. 

Uefa said players “can choose their preferred beverage” at the tournament. Coca-Cola did not respond to a request for comment. 

England manager Gareth Southgate defended corporate sponsorships on Thursday, saying “their money at all levels helps sport to function”. That stance was supported by his team’s captain, Harry Kane, who added: “Obviously the sponsors are entitled to do what they want if they’ve paid the money to do so.”

There have long been precedents for athletes favouring their own marketing deals over the groups they play for. At the 1992 Olympics, US basketball player Michael Jordan opted to cover the Reebok logo on his official uniform with a strategically draped American flag, a gesture of loyalty to Jordan’s personal sponsor, Nike.

But more recently athletes have gained greater control over which brands they are associated with, thanks in large part to their direct link to fans through social media. 

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Osaka, the world’s highest-paid female athlete, has accrued a suite of her own sponsors and a large social media following thanks to her brilliant playing record, but also frank advocacy for racial injustice and mental health. 

This breed of independent-minded athletes at the top of sport is forcing a rethink of the longstanding marketing strategies adopted by competition organisers and their sponsors.

“There’s still going to be a billion servings of Coke poured today, tomorrow and the next way,” said Crow. “But the question is: is there a better way of doing it? I suspect there is a better way to get its message across than plonking bottles in front of athletes.”



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Analysis

Biden’s climate agenda bogged down in divided Congress

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President Joe Biden arrives back in the US this week after a foreign tour with a recurring theme: fighting climate change.

But he returns to a Washington where his own party feels increasing anxiety that his administration’s climate agenda will fall short at home.

Bipartisan talks over Biden’s infrastructure proposals — which would spend billions on crumbling roads, bridges and tunnels, as well as record sums on clean energy — are flagging. While Republicans and moderate Democrats try to scale down the package, progressives warn they will withhold support if climate provisions are stripped out. 

“If there is no climate, there is no deal,” Jeff Merkley, a Democratic senator from Oregon, said this week. “When the ship sails on infrastructure, energy infrastructure cannot be left on the docks.”

Democratic party leaders are now exploring another path to enact Biden’s climate plan. Chuck Schumer, the Senate majority leader, on Wednesday met his members on the budget committee to find ways to fund greener electricity, zero-carbon vehicles and manufacturing and farming that keeps many climate goals intact.

While potentially more viable, the strategy could also weaken Biden’s climate policies. Legislation would be shoehorned into the Senate’s budget reconciliation process — a special procedure that enables Democrats to use their slim majority but constrains the scope of what can pass.

Column chart of US generation by fuel source, in a scenario where emissions fall 90 per cent by 2040 (TWh) showing Cutting carbon from electric sector would displace coal and gas

Biden has pledged for the US to cut emissions by at least 50 per cent from 2005 levels by 2030. He is aiming for carbon-free electricity by 2035 — a target that would mean none generated by burning coal or natural gas unless their emissions can be captured.

These lofty climate policies were a centrepiece of Biden’s diplomacy on his first international trip. He told G7 leaders in Cornwall that global warming is “the existential problem facing humanity”, and helped launch a $2bn fund for countries to shift away from coal.

In Washington, however, Democrats look unlikely to pass ambitious climate legislation with the support of Republicans given the 50-50 party split in the Senate and rules requiring at least 60 votes to move most important bills.

“I think there is reason to be concerned,” said Dan Lashof, US director of the World Resources Institute, referring to the fate of climate proposals in Congress.

“It was always going to be a challenge, to get investment at the scale that is needed, to turn the corner on climate change,” he added. “Getting very substantial investments in infrastructure and clean energy technologies is crucial to reaching the US emissions targets.”

The reconciliation process proposed by Schumer requires a simple majority vote, but rules limit it to tax and spending measures. Far-reaching initiatives to drive down the US’s 6.5bn tonnes of annual carbon emissions would be in jeopardy.

Using reconciliation would make it hard to establish a “clean electricity standard,” a core part of Biden’s plans to tackle emissions. The standard would set ever-stricter emissions targets for electric utilities, which are the source of a quarter of the country’s greenhouse gas emissions.

“The clean electricity standard is a much harder provision to enact through reconciliation and the reason is pretty simple: it’s a standard,” said Paul Bledsoe, strategic adviser at the Progressive Policy Institute. “Forcing the square peg of a clean electricity standard into the round opening of the reconciliation process will be very difficult.”

One workaround under discussion among Democrats is to pay incentives for clean electricity, achieving some of the goals of the electricity standard while fitting within the guidelines of reconciliation.

“It would involve the federal government becoming a partner in the transition, helping utilities that are making progress at the pace and scale necessary with financial investments,” said Leah Stokes, an assistant professor of political science at the University of California, Santa Barbara.

Other parts of the Biden climate agenda — including expanding tax credits for wind and solar power and energy storage and creating a credit for power transmission lines — would be more straightforward under the reconciliation process. Policies that do not depend on legislation, such as vehicle emissions rules, can be directly imposed by the Biden administration and are expected soon.

Adding urgency to the legislative push are the midterm elections in 2022, when Democrats risk losing control of the Senate or the House of Representatives.

“The rest of the world is intimately familiar with midterm elections and how the US Senate works, because they are concerned that the domestic delivery of the climate promises is imperilled by the toxic politics here,” said Rachel Kyte, dean of the Fletcher School at Tufts University. 

Republicans have argued that the infrastructure proposals should focus more on roads, bridges, and construction projects and objected to provisions that would subsidise electric cars and support non-fossil energy. 

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Meanwhile, not all Democratic senators are aligned. Joe Manchin of West Virginia, a coal-producing state, is likely to have a decisive influence on the shape of any climate proposals as his vote would be needed to pass bipartisan or reconciliation bills.

Energy experts acknowledge that achieving zero-carbon electricity by 2035 would be daunting even if a clean electricity standard was to pass, because of an ageing US grid. 

Patrick Luckow, analyst at IHS Markit, expects power demand to rapidly increase over the next decade as more vehicles and home heating systems run on electricity. “When you are adding renewable energy and getting rid of fossil fuels, there is demand growth as well, which makes it more challenging,” he said.

Democrats say Biden needs a win on climate for political reasons as much as environmental ones. “The Democrats can’t risk the failure of Biden’s climate and economic policy. It would cripple the president,” Bledsoe said.



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Analysis

Mexico enjoys break from economic gloom with the help of Biden

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Business gloom has been so pervasive in Mexico since Andrés Manuel López Obrador won the presidency in 2018 on a strident anti-establishment platform that a recent burst of optimism about the country’s growth prospects feels like a ray of sunshine breaking through the clouds.

Last October, the IMF was forecasting that Mexico would grow just 3.5 per cent in 2021 after shrinking a seasonally adjusted 8.5 per cent last year during the pandemic. Yet as the economy rapidly opens up, coronavirus infections remain low and the effects of the giant US stimulus ripple across the border, many economists and bankers here now see Mexico expanding almost twice as fast. 

“The combination of continued reopening with strong remittances and a US-led global recovery has allowed Mexico to close the gap with other Latin American economies, outperforming all of them in the first half of 2021,” said Marcos Casarín, chief economist for the region at Oxford Economics. The consultancy’s recovery tracker shows Mexico is returning to pre-pandemic levels of activity more quickly than any other Latin American country.

“Mexico will grow 6.0 per cent this year and it could be higher,” said former finance minister and academic Carlos Urzúa, citing the spillover effects of US fiscal stimulus and increased remittances from Mexicans working across the border. These could reach $55bn this year and are “much more important than oil”, he added.

But few believe this year’s US-inspired growth spurt heralds a bright new dawn for Mexico. The expansion, bankers and economists say, is almost entirely thanks to President Joe Biden’s policies, rather than López Obrador’s. The biggest beneficiaries are Mexico’s export-oriented manufacturing companies in the north of the country and the tourism industry, while firms servicing the domestic market struggle with depressed demand.

“Mexico will grow 6 per cent this year whether it likes it or not, dragged along by the US,” said one dealmaker who runs an investment fund in the country. “It will grow quite well in 2022 also. That’s not the point. What matters is what happens after 2023.”

Here the picture is much less sunny. A near-universal complaint in the business community is that López Obrador’s hostile rhetoric, constant attacks on regulators and the judiciary, his unpredictable policy announcements and preference for state-owned companies have scared away the foreign money that should be coming to Mexico to take advantage of preferential access under the US-Mexico-Canada free trade agreement.

“The ritual of bringing the global CEO to Mexico to announce a new investment is over,” said one leading member of the international business community. “There is a pause. Nobody is leaving the country but nobody is proposing incremental investment either.”

The example cited most often as deterring investors is the energy sector, where López Obrador is attempting to reverse an opening to private money begun under his predecessor and revert to a state-run fossil fuelled model, throttling a once-promising renewable energy boom in the process.

“The problem is investment and the issue is medium-term and long-term,” said Gerardo Esquivel, deputy governor of the central bank. “It’s been stagnant since 2015-16.”

Urzúa said that public investment would be only 2.7 per cent of gross domestic product this year, barely more than half the level it should run at. Much of the spending is directed towards López Obrador’s pet projects, which include a new oil refinery in his home state of Tabasco and a new tourist railway around the Yucatán peninsula.

Despite his government’s focus on social programmes to help the poor, López Obrador stands out from other populists for his stubborn refusal to increase borrowing to allow more spending. Most economists here do not believe that his decision last week to switch finance minister and appoint longtime ally Rogelio Ramírez de la O, 72, will change this.

Those close to the president say his aversion to debt stems from a conviction that the Mexican governments he admires most in the 1960s and 1970s were crippled by excessive borrowing. “Amlo turns into a panther when you suggest that he should take on more debt,” said one former minister. “It’s simply not something you can discuss. He will not spend.”

Even amid the pandemic, López Obrador was one of the very few presidents in the world to reject extra borrowing to alleviate suffering, despite the fact that Mexico had the fiscal space to do so. Critics dubbed his policies “austericide”. And while public investment remains weak, the president does little to encourage the private sector to take up the slack.

“López Obrador must promote private sector investment,” said the CEO of one Mexican bank, adding that the private sector accounted for 86 per cent of Mexico’s total investment. “There is no way to grow without private investment. “This rejection of private investment has to stop.”

And as for Mexico’s recovery: “To grow 6 per cent this year and 3.5 next year is not magic, it is inertia.”



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