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Bonds Slump as Meeting of European Chiefs Buoys Defense Stocks

(Bloomberg) -- Investors sold European bonds and bought defense stocks on speculation a meeting in Paris between the bloc’s leaders will point toward higher spending on the continent’s security.

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The German 10-year yield rose as much as seven basis points to reach 2.50%, while the euro dipped and defense firm Rheinmetall AG hit a record high. US Treasuries are closed for a national holiday, though futures implied an increase in the 10-year yield of about 1 basis point.

The moves were sparked by concern the region will need greater debt issuance to fund military investment, as US peace proposals suggest America is losing appetite to support Ukraine. Upgrading defense and protecting Ukraine may cost Europe’s major powers an additional $3.1 trillion over 10 years, Bloomberg Economics estimates.

“Whichever way the peace process goes, it is clear that Europe will need to increase more spending on defense to provide security to Ukraine,” said Mohit Kumar, chief strategist at Jefferies International. That outlook implies “upward pressure on European rates and steeper curves.”

French President Emmanuel Macron invited regional leaders including Germany’s Olaf Scholz and Italy’s Giorgia Meloni to Paris on Monday for urgent discussions on Ukraine and the continent’s security, according to people familiar with the plans.

EU member states would need to allocate an additional 0.8% of gross domestic product on average per year if NATO were to increase its defense expenditure target to 3% from 2%, according to ratings agency Scope. Spain and Germany would be among the most affected, having to increase spending by nine percentage points and seven percentage points respectively, Scope said.

The fresh focus on defense is throwing the spotlight once again onto the future of joint bond issuance, a thorny political issue that’s long divided members of the bloc.

In an interview with Bloomberg TV, Benjamin Haddad, France’s minister for European affairs, said the matter should be discussed in the coming days as the bloc tackles an “existential moment” over Ukraine.

Goldman Sachs Group Inc. economist Filippo Taddei expects the EU to fund greater defense spending by first tapping national debt and then via the NextGenerationEU program, a temporary tool under which billions of euros in bonds were sold to support Europe’s economic recovery from the coronavirus pandemic.

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