Joint Eurobond ETF Fallout

August 31, 2011

The EU’s plan to issue bonds jointly by eurozone members is good news for some ETF investors and possibly bad news for others.

According to Bloomberg, European Union regulators hope jointly issued bonds will finally quell the sovereign debt crisis that has plagued the continent since early last year.

Details have yet to be worked out, but a joint eurobond offering would essentially spread debt obligations and liabilities among all the eurozone’s member states. The idea is that a joint eurobond would bring better financing to states in need, like Greece and Italy, than would Greek or Italian bonds denominated in euros.

The only problem is that countries like Germany, which has the largest economy in the eurozone, would be largely responsible for the debt, and thus face higher borrowing costs than it’s normally accustomed to. That probably explains Germany’s opposition to the European Commission plan.

That said, jointly issued eurobonds could be quite beneficial for investors in the Rydex CurrencyShares Euro Trust (NYSEArca: FXE). Though FXE investors have gained 7.68 percent year-to-date, they’ve had to deal with considerable volatility. A move to issue joint eurobonds may prove costly for Germany, but would certainly put to rest any speculation that the sovereign debt crisis could end the euro.

Potential Winners

As of now, FXE is still susceptible to the news concerning Europe’s sovereign debt problems. With restructuring agreements not yet in place in Spain and Italy, investors still face a bumpy ride. It’s clear that addressing debt issues one country at a time will certainly bring more volatility to the likes of FXE.

Investors in European equity ETFs may also stand to benefit quite bit from a joint eurobond offering, in large measure because of currency movements, which we’ve talked about in the past.

Among the equity ETFs that would likely benefit from new jointly issued eurozone bonds are the SPDR STOXX 50 (NYSEArca: FEU) and the SPDR Euro STOXX 50 (NYSEArca: FEZ). Year-to-date, FEU and FEZ have dropped 4.13 percent and 8.68 percent, respectively. A rally in the euro resulting from a joint-bond offering would directly correlate to better returns for investors in these funds.

Germany ETF Hangs In The Balance

However, one group of ETF investors that may stand to lose some ground in a joint eurobond offering are those that have extolled Germany’s capacity to weather the global upheaval of the past few years remarkably well.

Those holding the iShares MSCI Germany Index Fund (NYSEArca: EWG) have some reason to be cautious. More than 18 percent of the fund consists of consumer discretionary stocks. Should Germany find itself even more responsible for the debt of euro member states, there’s no way to tell how that may affect German taxpayers and therefore their capacity to spend discretionary income.

Obviously, this is purely speculation, but it isn’t far-fetched to assume that German taxpayers will face a greater burden should joint eurobonds come into existence.

Even so, EWG could stand to gain from a rally in the euro, particularly if jointly issued bonds end up stabilizing the eurozone, thus preserving—even enhancing—Germany’s exports to its neighbors in Europe.

At this point, all we can do is wait and see what happens as Europe’s politicians try to pull together and hatch a more comprehensive plan to right the ship. You can be sure, though, that a definitive solution must be reached. Otherwise, the bumps in the road are sure to get bigger.

 

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