Look for big bond issuance in Europe

With all eyes on US, big bond issuance is coming in Europe, says Stuart Chilvers, Rathbone Greenbank Global Sustainable Bond Fund Manager.

Given all the (understandable) focus on US fiscal sustainability – only heightened by the recent passage of the One Big Beautiful Bill – you might have expected long-dated US treasuries to have underperformed recently. However, at time of writing the 30-year treasury yield has risen just 8 basis points (bps) this year. This compares to 30bps for the 30-year gilt and 61bps for the 30-year bund (all as of 10 July close). While the conversation in the US turned swiftly to the effect on the bond market, that conversation never really got started in Europe. Instead, it was drowned out by the ‘Liberation Day’ tariffs. But investors are starting to take note in the background.

If we think back to earlier in the year, the sharp rise in the 30y bund yield shouldn’t come as much of a surprise. Shortly after the German February election, the CDU, SPD and Greens agreed to one of the largest fiscal expansions in Germany’s post-war history: a €500 billion infrastructure fund and defence spending above 1% of GDP – both excluded from the calculation of the debt brake – and relaxed the legal requirement for German states (the Länder) to run balanced budgets (they can now borrow up to 0.35% of GDP each year). We had reduced our Rathbone Greenbank Global Sustainable Bond Fund’s exposure to euro duration earlier in the year, as we had anticipated a fiscal loosening from Germany. Albeit, we hadn’t expected anything of this scale!

All this has come back into focus in recent weeks as the German cabinet approved the full draft budget for 2025, as well as giving the green light to key figures for the 2026 budget and the medium-term fiscal plan for 2027-29. These detailed a faster ramp up in deficit spending and hence net funding needs than many had expected. If borrowing numbers translate one-for-one to net bond supply, we could potentially see the net supply of bunds balloon to €170bn each year for the foreseeable.

German government set to issue roughly 50% more debt to private investors next year than in the past 20 combined
This may slightly overstate supply, as, for instance, short-dated T-bill issuance will likely play some role – Barclays estimates net supply of €140bn next year. However, we need to add the supply that will come to market from the European Central Bank’s (ECB) quantitative tightening, where it’s running down the pile of European government bonds that it bought up in the aftermath of the Global Financial Crisis. As this is effectively ‘supply’ the market will need to absorb, that takes us to effective net issuance of north of €220bn next year (and we expect it to remain around that level in the years following). To give that some context, the cumulative net sales of German government bonds to private markets for the 20 years to 2025 was just €150bn. This shows the effect that balanced budgets before COVID as well as quantitative easing (QE) had on reducing the net supply (as markets don’t have to absorb supply purchased by the central bank’s QE programme.

It will be interesting to see if this massive increase in issuance will change the maturity make-up of the German debt market going forward. In the UK for instance, we have seen a drastic cut in the percentage of debt raised from the long end of the curve, while Japan has also reduced long-dated auction sizes in favour of shorter-dated bonds. Meanwhile, US Treasury Secretary Scott Bessent has shown no desire to extend US debt maturities with yields at current levels.

It seems unlikely that Germany will take as drastic action as in the UK. The head of the German Finance Agency in an April interview said, “Ultra-long bonds have been repeatedly reviewed and could be an interesting addition. First, they are attracting interest from investors. Second, they could fit well into our portfolio… Nothing has been decided yet.”

Set against this, German officials will need to consider the Dutch pension fund transition. Historically, this €1.9 trillion sector would have been an expected buyer of long-dated European sovereign supply. However, the impending transition to a defined-contribution model is expected to deliver a material decline in demand for long-dated bonds from this sector.

Finally, we believe that the ECB is, if not at the end of its rate-cutting cycle, then extremely close to it. We felt the June meeting took a notably hawkish turn, with the minutes making a more balanced assessment of growth risks and referencing the impact of fiscal announcements. Recent commentary from ECB speakers have reinforced this view, in our opinion, albeit we acknowledge that higher tariffs still present an uncertainty. Depending on the eventual outcome, they could require a deeper cutting cycle.

Taking all of the above together, we have again been slightly reducing our exposure to euro duration within our fund in recent weeks. In particular, we have focused on selling long-duration euro bonds given the points covered above. We are generally comfortable with shorter-duration euro credit though. In fact, we could see the wider euro credit market benefit if a ‘de-dollarisation’ trade materialises in coming years.