Debut EU recovery fund bond rallies sharply, investors await Fed

© Reuters. FILE PHOTO: European Union flags flutter outside the EU Commission headquarters in Brussels, Belgium May 5, 2021. REUTERS/Yves Herman/File Photo

By Yoruk Bahceli

(Reuters) - The first bond sold backing the EU's COVID-19 recovery fund rallied strongly a day after issuance on Wednesday, while euro area government bond yields dipped as investors awaited the outcome of the U.S. Federal Reserve's policy meeting.

The European Union raised 20 billion euros ($24.26 billion) from a 10-year bond sale on Tuesday in the largest-ever single-tranche institutional debt sale that saw near-record demand of 142 billion euros.

That kicks off up to 800 billion euros of bond issuance until end-2026 to finance the recovery fund that will establish the EU as a leading issuer.

The bond rallied sharply in the secondary market in further evidence of strong demand, demonstrating that the market easily absorbed the vast issuance.

The yield, 0.086% at pricing, fell nearly 6 basis points to 0.035% on Wednesday.

The rally was similar to that following the EU's first debt issuance backing the SURE unemployment scheme, a smaller support programme.

"Even we're a little surprised that it's managed to perform that well that quickly, given the size," a banker involved with the bond sale said.

Investors were keen to buy the first issuance of what will become a much more liquid funding programme than SURE, while a recent cheapening of EU debt also helped to attract investors, the banker said.

The ECB's decision to uphold accelerated bond purchases for the third quarter has also given investors confidence to buy into sizable debt sales.

In the broader market, bond yields dipped as the focus was on the conclusion of the U.S. Federal Reserve meeting.

Germany's 10-year yield, the euro area benchmark, was down nearly a basis point to -0.24%, along with most other 10-year yields.

Fed officials are expected to at least flag the pending start of talks on tapering its bond purchases, while attention will also be on new interest rate and economic projections to show how much policymakers' views have changed since March.

In recent weeks, bond yields, which have fallen on both sides of the Atlantic - closely correlated - have shrugged off a spike in U.S. inflation.

"U.S. yields will probably be the main driver of direction of European yields over the coming three months and I think the Fed rhetoric on tapering and where their inflation targets are will be of interest," said Nick Sanders, portfolio manager at AllianceBernstein (NYSE:AB).

In the primary market, Germany will raise 5 billion euros from the auction of a new 10-year bond.

($1 = 0.8244 euros)