EU Borrowing Costs Jump as Index Snub Raises Concerns

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The European Union (EU) faced a setback on Thursday as its borrowing costs rose following MSCI’s decision not to include EU debt in its government bond indexes. This decision surprised the market, which had anticipated the EU’s inclusion and had seen EU bonds outperforming those of its member states in recent weeks.

Initially, the EU’s 10-year bond yields rose by as much as 7 basis points to 3.13%, while its 30-year yields increased similarly to 3.51%, according to Tradeweb prices. Although these yields later moderated to around 5 basis points higher on the day, they still underperformed broader euro zone government bond markets, where yields rose by only 1-2 basis points. Bond yields move inversely with prices, indicating a sell-off in EU bonds on Thursday.

Despite the disappointment and sell-off, EU bonds maintain their top Triple A credit ratings, leading some market participants to view the price adjustment as an opportunity, making EU bonds potentially more attractive. Importantly, even after Thursday’s selloff, EU bond yields remained lower than those of France, which saw its yields spike earlier in the week due to domestic political developments, including President Emmanuel Macron’s decision to call a snap election.

The EU has emerged as a major borrower in global bond markets, planning to raise up to 712 billion euros by 2026 through joint debt issuance to fund COVID-19 recovery efforts. The inclusion of EU debt in major bond indexes is crucial for aligning it with sovereign debt and increasing investor demand. While MSCI’s decision was disappointing, the EU continues to seek alignment through consultations with other index providers like Intercontinental Exchange (ICE).

Looking ahead, the fiscal integration efforts within the EU will play a pivotal role in determining the perception and attractiveness of EU debt. Concerns remain about the temporary nature of the EU’s pandemic borrowing program and potential political challenges, particularly regarding fiscal policies and defense spending, should there be a shift in governance within member states like France.

In summary, while MSCI’s exclusion decision was a setback for the EU’s ambitions, the longer-term creditworthiness and strategic objectives of EU debt issuance remain intact, contingent on continued fiscal integration and market alignment efforts.