The safe asset potential of EU-issued bonds
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Saturday, January 21, 2023
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The lack of euro-denominated safe assets and the fragmentation of the market are problematic.
Key Points:
- The lack of euro-denominated safe assets and the fragmentation of the market are problematic.
- In the absence of a supranational euro-denominated safe asset, a flight to safety would entail capital flowing out of vulnerable countries and into safe havens.
- Both initiatives were proposed in the context of the EU’s response to the recession in the wake of the coronavirus (COVID-19) pandemic.
- As of December 2021, the amount of outstanding EU bonds had grown to €215 billion in total.
- The first SURE bonds were issued in October 2020, while the first NGEU bonds were issued in June 2021.
- By 2028 NGEU volumes are foreseen to reach €800 billion, more than twelve times the level in December 2021.
- Including the approved funding for other smaller programmes, the total available amount of EU bonds is set to exceed €1 trillion by 2028.
- This stability of EU yield spreads does not mean that EU bonds will automatically become a supranational euro-denominated safe asset.
- A safe asset is traded in liquid markets.
- Market liquidity ensures that investors can sell their asset at any time without causing a major change in the market price.
- (2022) we also argue that a safe asset’s market liquidity should be sufficiently high to accommodate central banks’ monetary policy operations.
- Finally, the perception of EU bonds as safe assets also hinges on the continuation of their favourable regulatory treatment.
- For such an instrument to be viable, a deep and liquid repo market would need to evolve first.