Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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EU Superfund for climate, energy and defence announced, to be funded by private pensions
Christopher Dembik
Head of Macroeconomic Research
Summary: To defend against the rise of populism, deepen the commitment to slowing climate change, and defend its borders as the US security umbrella recedes, the EU launches a bold $3 trillion Superfund to be funded by pension allocations rather than new taxes.
The security umbrella provided by the US during the Cold War and afterwards over much of Eastern Europe is rapidly fading and threatens to fail entirely in the years ahead as the US looks east at far more serious economic and military rivals. Signs of this were already clear with the popular and withering attacks on NATO allies by former president Donald Trump and his demand for them to pay more. Then the AUKUS submarine deal stiffed France’s attempt to sell new submarines to Australia, as post-Brexit UK, Australia and the US moved into a new security arrangement that left a very cool feeling down the back of continental Western Europe and the EU.
The EU knows it needs to move fast on all fronts to bolster its defences and is also looking for a way to jump-start flagging economies buffeted by the energy and power crisis of 2021-22. French President Macron, backed by Italian Prime Minister Draghi moving to stave off Italy’s own rise of the populists, rolls out a vision for an “EU Superfund” that will address the three-fold priorities of defence, climate and the related clean energy transition. Given the EU’s aging population and heavy tax burdens, policymakers know that it will be impossible to finance the Superfund with higher taxes on incomes or other traditional tax revenues. Instead, France has a light-bulb moment as it seeks to overhaul its pension system and looks at Europe’s enormous pensions. It decides that all pensions for all workers above the age of 40 must allocate a progressively larger portion of their pension assets into Superfund bonds as they age. This allows new levels of fiscal stimulus in the EU even with the sleight-of-hand trick of hiding the spending in inflation and negative real returns on low-yielding Superfund bonds that are actually EU bonds in disguise. At the same the younger generation enjoys a stronger job market and less unfair tax burdens as the system proves such a success that income taxes are lowered progressively.
Market impact: Bond yields harmonise across Europe, leading to German Bunds underperforming. EU defence, construction and new energy companies are some of the best performers.
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