A combination of factors will result in spreads continuing to widen well into 2025 for the European public sector bond market. These include high supply, geopolitical risk, political uncertainty and the end of the European Central Bank’s quantitative tightening programme.
At an OMFIF event hosted in partnership with LBBW, funding officials and fixed-income portfolio managers examined the outlook for European sovereign, supranational and agency borrowers for the year ahead.
A senior syndicate banker described 2024 as ‘a bit of a challenge because everyone tried to be front loaded with the US election and a lot of events going on throughout the year’, noting that ‘nobody expected the outcome of the European elections and the volatility around France’.
‘When the year progressed, we had situations where the less liquid names, their secondary curves simply traded at levels where they could never issue transactions,’ said the banker. ‘Even the liquid issuers who had bonds outstanding from five years ago at maturities of 15 or 20 years, you couldn’t get bonds at these levels.’
This has left a serious amount of uncertainty in the market. ‘We see that there is a resistance from investors buying into this asset class at the moment, not because they don’t like the spreads and they have a completely different view on where they should be, but because they are afraid that the widening continues,’ said the banker. ‘For example, if you buy something now, which is 10 basis points wider in six weeks, then you better buy in six weeks, and not now.’
The widening of spreads in the European SSA market offers a sharp contrast to the credit market where spreads are tightening despite elevated levels of supply.
The syndicate banker expects this to continue this year: ‘We will have a similar scenario in that, when you speak to investors, they expect spreads to widen at least until Q2,’ said the syndicate banker. ‘Supply will be similar or slightly higher, but with QT having completely ended.’
However, the expectation is that, if the first few deals of 2025 show a strong market environment, there will be room for some tightening. But this will against a backdrop of a number of key political events such as the inauguration of Donald Trump as US president and the German federal elections in February, which may easily derail sentiment. Issues in France will also be closely watched as they could have wider repercussions for the market.
A ‘juicy’ opportunity
For some investors, the widening spreads offers an opportunity. ‘We started picking up bonds that you would get for mid-swaps plus 5bp at around plus 10 in the summer of 2023, which for us, was – excuse the term – very juicy,’ said a fixed-income portfolio manager. ‘So we jumped into these bonds. But the euro primary bonds that came after the summer were actually wider. Then by the beginning of 2024 we were at mid-swaps plus 20bp in the primary market for 10-year bonds and right now we are in the 30s.’
The portfolio manager said his firm has ‘a very high risk appetite towards supras in general, but especially European ones,’ which are among its highest allocations.
He was confident about his firm’s position going into 2025, but was sanguine about the risk entailed: ‘Unfortunately, all the funding needs that Europe has to face plus the geopolitical risks will lead to a widening of credit spreads. But we don’t look at it from a negative point of view, rather the opposite. We are spread takers.’
If liquidity remains good in the European SSA market, then that is enough for some investors to continue buying despite widening spreads.
Burhan Khadbai is Head of Content, Sovereign Debt Institute, OMFIF.
A full transcript of the roundtable will be published in January 2025, featuring extended discussions with the European Union, European Stability Mechanism, fixed-income investors and LBBW.
