Market Eyes New European Union Bonds Try to Improve Defense

The bond market calms down in the face of potential capital surge

The chance of joint lending is higher than at the end of last year

The growth impact of defense spending is crucial – Goldman Sachs

LONDON, Feb. 26 (Reuters) – Big investors believe new European lending efforts are increasingly likely as the region scrambles to increase its defence spending.

The modest reaction of the bond market, often confusing by the pace of defense negotiations this month, suggests investors believe borrowing increases to date.

They also said that this also shows that the market expects the European Union to create an 800 billion euro (USD 840 billion) pandemic recovery fund to generate another common European financing five years after the European Union was established.

At the end of last year, investors believed that the possibility of joint borrowing from the EU itself was less likely. But Europe and immense pressure on the Ukrainian war have reappeared as the Ukrainian talks ended the fringe Europe of the Ukrainian war and the spending on U.S. President Donald Trump.

The EU believes that 500 billion euros are needed in the next decade. However, increasing defense spending to 3% of output would require nearly €200 billion per year.

Germany’s 10-year yield was less than 10 basis points after Trump began dialogue with Russia, but has since reversed the move.

Additional yields Italy and Spain spend less than 2% on defense, and these debts are barely transferred.

“The knee jerk (response) is that the government starts spending extra money, but that’s not going to be big,” said David Zahn, head of European fixed income at Franklin Templeton.

He added: “A lot of money must come from some type of concentrated funding because most of Europe’s budgets are relatively high.”

He has sold EU bonds expected to have more co-issues, while the Pioneer insists on betting on Italian and Spanish bonds.

“If they[the decision makers]are serious about this, then we will have to consider when issuing UN defense bonds,” said Nicolas Trindade, fund manager at AXA Investment Manager.

“That’s where you have the greatest ability.”

Some analysts believe that even Germany will face a huge spending shortage and that it may benefit from joint lending that has so far opposed unless it agrees to a new defense fund.

Germany is seeking hundreds of billions of euros in defense spending before a new parliament could prevent the move.

Whether it is a new funding tool, including UK or more EU bonds – the most popular result for investors, making the group a more permanent borrower – although there is no immediate joint solution.

First, the group is considering a budget deficit rule for temporary exemption of defense spending. It could then transfer approximately €90 billion of unused loans to defense in its recovery fund.

Kaminiac economist Apolline Menut said further joint lending may not arrive until 2027, adding that Germany’s efforts to find a fast national solution may also be reduced Urgent.

The problem is how many additional borrowing investors they will tolerate when they have purchased record euro zone debt and are upset about the high deficits in the big economies.

Investors say it is hard not to know how much it will cost and within what time frame it will make a judgment.

The UK aims to gradually increase spending in a few years.

Long-term borrowing costs have exceeded shorter bonds since 2022, indicating more bond sales are expected.

Higher defense spending supports a steeper yield curve, said asset managers including AXA, Allianz Global Investors and Northern Trust.

However, Germany’s 10-year yield is about 2.5%, almost 2 percentage points lower, even Italy’s 80 basis points.

“The yields in Europe are currently quite reasonable. I don’t think that’s a major limitation,” said Zahn of Franklin Templeton.

Citi pointed out that since the European Central Bank stopped hikes in 2023, Germany’s yields have remained basically unchanged. Thereafter, the amount of debt investors need to purchase only increases.

It still believes that yields could end up below 2% as stricter financing conditions prompt more interest rates.

Bond investors also want to see if defense spending can boost growth in the euro zone, thus making debt levels more sustainable.

Filippo Taddei, senior European economist at Goldman Sachs, believes that every additional defense spending that initially only 40 cents would increase by 40 cents.

If the industry is strengthened and productivity is increased, the impact may be greater.

“It’s obviously unclear…but the market is pricing the good possibility that it might happen,” Taddei said. ($1 = 0.9522 euros)

(Reported by Yoruk Bahceli; Edited by Dhara Ranasinghe and Hugh Lawson)