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Summary
- Budget forecasts for growth are already being downgraded across the Eurozone.
- Germany and France have downgraded their outlooks; the European Commission (EC) has downgraded both and Italy too.
- Only Spain saw an increased forecast by the EC. Semi-core continues to look attractive given France has already announced spending cuts to prevent a deficit blowout.
- We continue to see a growing likelihood that Germany will abandon its balanced budget commitment to reform its economy.
- We highlight likely timings for new benchmarks across the EGB space.
Market Implications
- Supply dynamics suggest being long semi core EGBs. We like Spain vs Italy and Germany – it has begun to perform recently.
Go to: Eurozone Supply Outlook | New Benchmark Predictions
The Outlook for 2024
Our base assumption remains that in the largest EZ economies, there are upside risks in 2024 issuance. The recent stark downgrades in estimates for German and French GDP growth support this notion (Chart 1). Within this, France has already announced €10bn of cuts to offset the lower receipts, but Germany’s budget remains in flux. They approved a very low deficit earlier this year, but it seems unlikely to be sufficient.
Meanwhile, Spain saw an upward revision in the estimates of its GDP growth in 2024 by the European Commission. However, the budget assumption remains significantly above other estimates. Elsewhere, the revisions were unequivocally negative.
Our current estimates for duration supply (including QE effects) continue to suggest Italy will see the largest rise from 2023 to 2024, while Spain’s and France’s will remain relatively well capped. Germany’s looks capped too based on Treasury assumptions, but there are strong upside risks given the predicament the economy faces, and extremely optimistic real growth rates baked into their estimates (Chart 2).
The supply picture into 2024 continues to support relative outperformance of semi-core (French and Spanish) bonds versus core (German) and periphery (Italian) ones.
Charts 1: blue bars = budget assumption for 2024 growth, orange = IMF estimate, grey = analyst consensus, yellow = European Commission
Chart 2: net duration issuance by year: blue = Germany, orange = Italy, Grey = France, Yellow = Spain, Black = UK
Eurozone Budgets
Germany: Budget Woes Far From Over
Germany’s economic malaise continues. Economic Affairs and Climate Minister Habeck recently announced a downgrade in 2024 growth to just +0.2% – a drastic cut, much more in line with market consensus than the budget assumption (Chart 1).
The true scope of the 2024 budget remains unclear. A budget was approved at the start of February, allowing for just €39bn of new debt (0.35% GDP), albeit with scope for the debt brake to be halted should Germany need/choose to expand its support for Ukraine. Significant details, however, remain unclear, with the opposition CDU blocking resolution to the question of cutting agricultural subsidies. There may be no resolution for several months.
Further uncertainty comes from the mixed calls for how spending can be expanded.
The Economic Minister, Habeck, has floated the idea of a €30bn pa tax-credit fund for subsidising industry, which is suffering from high energy costs and the US IRA. Upside pressures on defence spending are likely, with Defence Minister Pistorius suggesting at the recent NATO security conference that 2% was the bare minimum for defence spending and could rise far higher if needed.
Our longstanding assumption is that Germany’s return of the ‘Schwarze Null’ debt brake will not survive. Whether this is done via alternate funds (as it was post-COVID), other accounting fudges, or ultimately changing the constitution remains to be seen.
Meanwhile, the Bundesbank is looking for +1.3% deficit; the independent Stabilitätsrat suggests +1.5%. This implies upside risk to the Finanzagentur’s expectation of €267bn in capital market and green issuance for the year.
The Finanzagentur has announced the discontinuation of inflation-linked bonds from 2024. They also syndicated a new 5Y and 10Y in January, as expected, as well as a new 2Y and 30Y in February. This is largely in line with our expectation, albeit we had expected the 2Y in January and the 30Y in April.
For the rest of 2024:
- April: New 15Y and 2Y
- July: New 10Y, 5Y, 2Y
- December: New 2Y
France: Growth Downgraded, Spending Cut
While not as drastic as the German downgrade, the French Finance Minister Le Maire has downgraded 2024 GDP growth estimate to just 1.0% (vs 1.4% previous). We had flagged a strong risk of this, but it is surprising how fast it occurred – and that it has brought a spending cut with it. Le Maire announced €10bn in spending cuts across departments and agencies to keep the deficit unchanged at 4.4% GDP.
Whether these cuts (alongside €15bn already in the 2024 budget) are achievable remains to be seen. At the same time, France has committed another €3bn to support Ukraine.
Meanwhile, as we had warned was a risk, there are now reports that the French deficit in 2023 may have been higher than targeted. This and the above support our continued expectation that there is upside risk to 2024 issuance (the Agence France Trésor continues to guide €285bn). However, compared with Italy and Germany, this upside is comparatively small.
Issuance in 2024 should follow a slightly heavier path than in 2023 (Chart 5). From a duration perspective, this will be exacerbated by PEPP winddown (Chart 6).
The French Tresor issued a new green 25Y and a new 3Y nominal in January (the latter in line with our expectation). They have additionally identified new nominal benchmarks in the 5/6Y and 10Y spaces, and the possibility for a new 30Y this year. In addition, a new 20Y EUR inflation linker is possible.
Our analysis suggests a new 5Y is due in February and a new 10Y in May, and that the 30Y could get a new benchmark in April.
Italy’s Finances Face Headwinds
The headwinds to Italy’s finances remain strong. The budget is predicated on a +1.2% growth rate: significantly above the average of other forecasters, including Banca d’Italia, which forecasts +0.6%.
The Italian Tesoro estimates 2024 gross capital market supply at €340-360bn. We expect it will be closer to €370bn (Chart 7). Duration will also worsen ahead due to PEPP’s winddown (Chart 8).
A big question this year will be who will absorb the increased supply of BTP duration. Currently the retail sector is taking a large amount of the issuance (Chart A). This lean will likely continue ahead, given the recent announcement of a third BTP Valore tap (26 Feb to 1 Mar).
In the nominal space, in February the Tesoro has issued new benchmarks in the 2Y (we had slated for March) and 15Y space. Our calculations suggest:
- The 10Y, will also come due imminently (we had previously flagged February). The risk of a 20Y that we previously flagged has probably decreased given the new 15Y.
- The 5Y does not seem imminently due, but if it does come in Q1, March would make most sense.
- A new 30Y could come due in April.
Spain
Spain’s estimates for real growth remain optimistic, but at the same time, it was the only major EZ nation to see an upgrade at the EU’s last forecasting round. This supports the Tesoro’s relatively positive outlook which sees a €10bn drop in net issuance to €55bn, although still a rise in capital market gross-issuance to around €175bn from €167bn (Chart 9).
The effect PEPP winddown should be less deleterious than for other countries due to the longer WAM of holdings.
A new 3Y was issued in January (a little earlier than we had expected), and a new 10Y and 30Y were issued in February (the former we had flagged). By our calculations, a new 5Y will come due in June.
Issuance in January was a little lower than we had expected, but the two February syndications will more than make up for this (Chart 9). The front-loading of issuance should allow reduced supply stress ahead, allowing for 10Y SPGB to outperform versus the likes of Italy and Germany.
Estimating New Benchmarks This Year
Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.
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