Euro Rates: Funding for the Recovery Fund to kick-off in June – 

The European Commission (EC) har announced its funding strategy for the Recovery Fund (see here) and confirmed its aim to kick-off issuing bonds under this program in June.

More specifically, it aims to raise around EUR 800bn up to the end of 2026 (which also includes around EUR 15bn left to finance under SURE and around EUR 42bn in redemptions) by issuing bills and bonds, of which around EUR 280bn will be green bonds.

The EC mentioned average annual issuance of EUR 150bn and we expect borrowing to be frontloaded due to the urgent need for the funds on the back of the Covid-19 impact on EU member states’ finances (see graph below). Overall, we expect the Recovery Fund to contribute around 1.1% to economic growth in the eurozone over 2021-2026.

EC’s expected borrowing requirement for the coming years

EUR bn

Source: EC, ABNAMRO Group Economics

EC will be well able to raise the funds in a market hankering for AAA rated paper – We are bullish about EU bonds as we expect the search for yield to intensify. On top of that, the liquidity of EU bonds is expected to improve significantly. Indeed, the EU curve will be comparable with the Dutch sovereign curve with regards to the size per line, which will be around EUR 10bn or even more.

In addition, the EU will maintain a curve up to 30y in the coming years. On top of that, demand for AAA rated paper has increased over time due to regulation whilst the supply of this paper is relatively scarce, especially once we correct for ECB purchases.

In addition, for foreign reserve managers, EU bonds will be an attractive alternative to German Bunds. Consequently, we judge that the issuance of EU bonds will result in a crowding in effect by investors, who left the market once the ECB started to buy significant amounts of bonds. This will all be supportive for EU bonds and provides an attractive environment for the EC to raise a significant amount of funds in the coming years. Recent new issue rounds under SURE indeed clearly showed that there is high demand for EU bonds.

Member states should receive first funds in second half of 2021 despite legal hurdles on the way – 

Even though the EC expects borrowing to kick off in June 2021, the Recovery Fund still faces some hurdles. Firstly, member states need to finalize their reform plans and have them approved by the EC. Secondly, still about a third of member states need to have the Own Resources Decision ratified by their national governments.

This sets amongst others the member states’ payment limits to the EU budget and creates headroom in the EU budget, which serves as a guarantee for EU borrowing. Germany put this ratification process on hold about three weeks ago, after a group of Eurosceptics filed an appeal to the German Federal Constitutional Court. The Constitutional Court is currently assessing whether the Recovery Fund is compatible with the EU treaties.

Even though it may take weeks, if not months, until the Constitutional Court will state its judgement, we don’t expect that the GCC will either force changes or stop the Recovery Fund in its entirety, since we see room in EU treaties allowing for the Recovery Fund framework. Even though we see some risks of further delays, we expect the first batch of funds to start flowing to the member states in the second half of 2021 under our base case.