Can Europe’s unified bond compete with US Treasuries?

Former Italian PM Mario Draghi’s push for a common safe asset could transform Europe’s financial system, but political and fiscal hurdles loom large

Former Italian Prime Minister Mario Draghi made the call for EU bonds in his hotly anticipated report on European competitiveness. EPA

The idea of an EU bond, a common safe asset, has been gaining attention lately, particularly following calls for its introduction this month by former Italian prime minister Mario Draghi.

Such a bond would represent a major step towards deeper financial integration within the eurozone, and may offer an alternative to US Treasury bonds as a global safe haven.

But while the idea holds promise, several big questions remain unresolved – chief among them, how the bonds would be structured, who would guarantee them, and how they would impact financial markets.

Mr Draghi, former head of the European Central Bank, made the call for EU bonds in his hotly anticipated report on European competitiveness, calling for an €800 billion ($893 billion) industrial strategy to boost Europe, which is lagging the US on key economic measures such as productivity. A good idea in practice, much harder to execute.

One of the biggest challenges facing the EU is determining who would back it. Unlike US Treasuries, which are guaranteed by the American government, an EU bond would need the support of multiple European nations.

This raises questions about who will take on the responsibility. The ECB’s primary mandate is to maintain price stability in the eurozone, primarily through monetary policy. It is not designed to directly guarantee debt issued by individual countries or even the EU itself, given its political independence, meaning the support for EU bonds would likely have to come from member states themselves. And that support would be essential to ensure market confidence.

The challenge is that this requires political agreement in a continent long defined by its divisions, and any prolonged negotiations could undermine the bond’s stability and perception as a safe asset.

The idea of an EU bond isn’t new – the eurozone issued syndicated bonds during the Covid-19 pandemic to prop up member states, backed by the collective EU budget – but it raises questions about how the risk would be shared in future.

Ideally, countries with higher credit ratings, like those holding AAA or AA ratings, would take on more of the burden. This isn’t about dividing the financial responsibility between “rich” and “poor” countries, but focusing on creditworthiness.

For instance, Italy, despite being one of the largest economies in Europe, has a relatively low credit rating due to its high public debt and political instability: it is rated BBB by Standard & Poor’s, just above junk status.

Treasuries have long been favoured because of the strength of the US dollar and its reserve currency status, but rising political risk, particularly around the coming presidential election in November, will have made investors cautious. An EU bond could offer a stable alternative, especially if European economies continue to show resilience.

While the growth forecast for the euro area in 2024 is modest, at around 1 per cent, it is expected to accelerate to 1.6 per cent in 2025, supported by a recovery in household spending and a robust labour market.

From a monetary policy perspective, EU bonds could also help the ECB function more effectively, such as when lending to European central banks, which would use these bonds as collateral. Having a single, standardised bond across all member states would streamline this process, reducing complications from handling various bonds from different countries. This would help the ECB implement its policies more uniformly.

There’s also the broader question of whether an EU bond would lead to greater financial stability across the eurozone. While Draghi’s push for a European safe asset doesn’t appear to be aimed at making the euro the world’s dominant currency, the introduction of an EU bond could certainly enhance the euro’s role in global markets.

A risk-free European bond would increase the euro’s attractiveness as a reserve currency and integrate European financial markets more closely, which remains one of Europe’s greatest financial challenges.

In theory, pooling risk through a common bond could lower borrowing costs for countries that usually face higher interest rates. It could also boost liquidity in European markets by attracting more investors, and encourage weaker economies to improve their fiscal discipline.

But that could spark political tensions between member states over sovereignty. There’s concern that more stable countries, which would bear more of the risk, could use this as leverage to impose stricter fiscal conditions on less stable member states.

To avoid this, the bond needs to be understood as a financial market instrument, designed to help businesses and strengthen markets, rather than as a means for governments to dictate fiscal policy.

In the end, while the proposal for an EU bond offers an exciting opportunity for Europe to strengthen its global standing, it also brings with it big challenges. The key will be designing a system that balances risk, garners political support and convinces investors that this new asset is as safe as its proponents, like Mr Draghi, claim.

Arturo Bris is professor of Finance and director of the IMD World Competitiveness Centre