Why EU bonds fail as a safe asset
This paper by Giovanni Bonfanti and Juri Marcucci examines why EU bonds, despite being jointly guaranteed by member states and carrying top credit ratings, persistently trade at a yield premium over safe euro-area sovereigns like Germany and the Netherlands.
Methodology
The authors combine several data sources: market yields and credit default swaps, detailed bond characteristics, confidential ECB holdings data by investor type, and information on mutual funds, ETFs, and the indices they track. They first rule out standard explanations for the spread such as credit risk, market size, liquidity, or regulatory treatment by comparing EU and supranational issuers with sovereigns of similar rating and scale. The authors then study how bond spreads respond to market stress, build a measure of how much benchmarked money is effectively “committed” to each bond via index inclusion, and analyze which investor groups hold EU bonds versus national bonds.
Findings
- EU and other supranational bonds pay a sizeable premium over German Bunds that is far larger than what their very low default risk would justify. This is because EU bonds fall more in price when markets are under stress, so investors that may need to sell in bad times require higher yields to hold them. The crucial reason is that EU bonds are legally classified as supranational rather than sovereign, which keeps them out of major government bond indices and leaves them with an investor base only a fraction of the size of that for national sovereigns.
- Holdings data show that flight-prone investors such as mutual funds and foreign central banks strongly prefer national government bonds, while more stable investors like banks and insurers are the main buyers of EU bonds, attracted by the higher yields. During the ECB’s 2022 tightening cycle, the spread on EU bonds quadrupled and their sensitivity to risk increased sharply, tracking changes in market expectations about whether the ECB would step in during crises.
Policy Implications
The authors’ simulations suggest that simply issuing more EU debt would only marginally reduce the yield gap, whereas recognizing EU bonds as sovereign in indices and market conventions could substantially lower their borrowing costs. The paper concludes that legal and market status, not fiscal fundamentals, currently prevent EU bonds from functioning as a true European safe asset and limit the euro’s ability to rival the dollar as a reserve currency.
A European Safe Asset? Not Without the Investors
Authors: Giovanni Bonfanti, Juri Marcucci
From: Columbia University, Bank of Italy
A Blueprint for Eurobonds
Olivier Blanchard and Ángel Ubide put forward a Eurobond architecture designed to address the structural weaknesses well documented in the Bonfanti and Marcussi paper above: the existing stock of EU-level securities — spanning EU, ESM, and EIB issuance — amounts to barely €1 trillion in total, is too fragmented and too small to function as a genuine rival to the US Treasury market. Rather than relying on gradual net new issuance, which would take decades to reach the necessary scale, the authors advocate a bolder approach: a large-scale, one-off exchange operation in which a significant share of member states’ national debt is retired and replaced with common senior Eurobonds, the so-called “blue bonds.”
How they propose to structure Eurobonds
Target size and objective
- Issue blue bonds up to around 25 percent of EU GDP (€5 trillion) by exchanging them for existing national bonds.
- This level is judged enough to create a deep, liquid safe‑asset market with a full yield curve, active repo and futures markets, and strong global demand.
Issuer and seniority
- Blue bonds are issued by the EU, not by member states.
- They are senior claims; the remaining national bonds become junior, so default and liquidity risk concentrates in the national layer while the common layer is very safe.
Backing and risk‑sharing design
- Instead of full joint‑and‑several guarantees, each government commits under domestic law to earmark part of its VAT revenues to service interest on its share of blue bonds.
- This creates strong, country‑specific repayment promises and keeps cross‑border risk sharing limited, which the authors see as crucial for political acceptability.
Implementation channels for the exchange
- Market purchases: the EU buys national bonds in the secondary market and issues blue bonds in parallel, allowing rapid scaling and active control of the new yield curve.
- Maturity replacement: as national bonds mature, they are replaced with blue bonds. A slower channel, but avoids disrupting markets.
- ECB balance sheet substitution: some national bonds currently held by the ECB (about €2 trillion) could be swapped for blue bonds, with those blue bonds gradually released as the ECB shrinks its balance sheet.
Relationship with existing EU instruments
Over time, EU‑bonds, ESM bonds, and possibly part of EIB issuance could be consolidated into the blue‑bond program to maximize size, liquidity, and simplicity.
Expected effects
- Create a genuinely deep and liquid European safe asset with yields likely below current Bunds, reflecting global demand for a euro safe asset.
- Lower average funding costs for all member states, even if junior national bonds carry somewhat higher spreads.
- Strengthen fiscal discipline by making junior national spreads more sensitive to country‑specific risks, while blue bonds provide a stable anchor.
- Support a more complete and integrated European capital market, including a better corporate yield curve and a weaker bank–sovereign doom loop.
- Achieve all this without changing EU fiscal rules or creating large new transfer schemes; the focus is on legal structure and market design rather than permanent fiscal mutualization.
Now is the time for Eurobonds: A specific proposal
By: Olivier Blanchard, Ángel Ubide – PIIE, Citadel
