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Note: we have split the EGB supply forecast from that of the UK, which we will update alongside the US following the UK.
Summary
- Budget forecasts for growth and labour market developments across the largest economies look optimistic.
- Germany and Italy’s look particularly optimistic. Germany in particular looks set to see deficit overshoot given its difficulty in cutting expenditure.
- 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 (Spain or France) versus core and periphery. We will expand further on this theme ahead.
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 (see our November piece for a more detailed overview). This is because European fiscal prudence is slipping, nominal growth will suffer from lower inflation, budget assumptions for real GDP growth look optimistic, as does the capacity to cut costs.
Analyst consensus estimates of GDP growth continue to greatly undershoot other estimates (Chart 1: blue bars = national budget assumption for 2024 growth, orange = IMF estimate, grey = analyst consensus, yellow = European Commission).
Germany’s budget assumption for growth has the largest overshoot compared to other sources, followed by Italy’s.
Our analysis for duration supply (including QE effects) suggests Italy will see the largest rise from 2023 to 2024, while Spain and France’s will remain relatively well capped. Germany’s looks capped too based on Treasury assumptions , but we note that there are upside risks to the deficit are perhaps larger there than elsewhere given the predicament the economy faces, and extremely optimistic real growth rates baked into their estimates.
The supply picture into 2024 should support relative outperformance of semi-core (French and Spanish) bonds versus core (German) and periphery (Italian) ones.
Eurozone Budgets
Germany: A Hard Time Balancing Its Budget
Our longstanding assumption is that Germany’s return of the ‘Schwarze Null’ debt brake will not last. Ultimately, a more expansive deficit will be needed. At present, Germany is looking for a deficit of just 1.75% GDP, of which 1ppt is interest cost, leaving a primary deficit of just 0.75%.
These plans are based on a 0.3ppt reduction in expenditure/GDP (primarily driven by a reduction in subsidy spend), alongside a 0.5ppt increase in revenue/GDP (on social contributions and production/import tax).
However, Germany’s capacity to cut spending while restructuring its economy is already being tested. Government proposals to phase out tax breaks on diesel fuel for farmers sparked immediate protests, and has already led to a backtracking.
The Finanzagentur is currently looking for €267bn in capital market and green issuance for the year, which is about in line with our estimate from last November of €270bn. However, we see strong upside risk to this number.
A number of new syndications have been highlighted for 2024:
- January: New 10Y, 5Y and 2Y
- April: New 15Y and 2Y
- July: New 10Y, 5Y, 2Y
- December: New 2Y
In addition, a new 30Y will also be syndicated (Aug33). New 30Ys have tended to come in H2, but it could come as soon as April given historic patterns for issuance (see end section). H2 would be more likely if they lean more on off-the-runs.
France: Upside Risk to Duration, but Less Than Elsewhere
France’s budget estimates for real growth are high versus other estimates, but not nearly so high as Italy or Germany’s. There remains a risk that the deficit overshoots this year (and consequently more capital market issuance than the €285bn the treasury is guiding).
The end of 2023 fiscal data shows a late catch-up in revenues, although the deficit looks to be larger than initially expected for the year. Much of this was probably covered by higher October and November issuance.
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). However, compared to Italy and Germany the rise in duration should be more modest.
The French Tresor has identified new nominal benchmarks in the 3Y, 5/6Y and 10Y spaces, and the possibility for a new 30Y this year. In addition, a new 20Y EUR inf linker is possible. Our analysis suggests a new 3Y is due in January, a new 5Y is due in February and a new 10Y in May. By our calculations the 30Y space could get a new benchmark in April.
Italy’s Finances Face Headwinds
Italy’s finances still face a lot of headwinds. The slower rate of PEPP winddown than anticipated offers a lifeline, but ultimately the market will need to price an environment in which reinvestment skew no longer provides a spread-tightening safety net.
With pretty optimistic fiscal expectations (second only to Germany in real growth optimism vs other estimates), the Italian Tesoro estimates 2024 gross capital market supply at €340-360bn. We expect it will be closer to €370bn (Chart 7). Duration will be even worse due to PEPP’s winddown (Chart 8).
A big question this year will be who will absorb the increased duration supply of BTP duration. The government may pressure banks to buy heavily, but further TLTRO maturities this year could reduce capacity to do so.
The Treasury will likely lean more on retail issuance which will offset some of the market pain from greater duration supply. Last year this was concentrated in H2, but earlier taps are possible.
The Tesoro has flagged a number of new syndications for Q1, including a 2Y, 3Y, 5Y, 7Y (already priced for January) and 10Y. Our calculations suggest:
- The 3Y and 10Y, will come due in February as well as possibly a 20Y (a tail risk given it sees irregular issuance).
- The 2Y will come due in March. 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 are optimistic, but less so than Italy and Germany’s. This leaves the Tesoro with a relatively positive outlook – able to reduce the net issuance requirement €10bn to €55bn, although capital market net-issuance is expected to increase to around €175bn from €167bn (Chart 9).
Duration supply will be further exacerbated by the PEPP winddown. However, the effect should be less deleterious than for other countries due to the longer WAM of holdings.
By our calculations, new 3Y and 10Y benchmarks will come due in February and a new 5Y will come due in June.
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.