The recent International Monetary Fund Article IV consultation and Financial Sector Assessment Program (FSAP) for the euro area (EA) have cast into sharp relief the region’s pressing vulnerabilities and institutional limitations. As the global macrofinancial environment enters a more uncertain and multipolar era, the EA finds itself in a now-or-never moment. A decisive pivot toward creating a large-scale, liquid and credible euro-denominated safe asset is not a mere technocratic improvement; it is a geopolitical and macrofinancial necessity. The fragmentation of European sovereign bond markets, the exposure of financial institutions to asymmetric sovereign risk and the absence of a unified yield curve severely constrain both monetary policy transmission and strategic fiscal coordination.

Against this backdrop, constructing a robust Eurobond market, anchored by a limited, senior “blue bond” structure, presents the most credible and pragmatic path forward. The question is no longer whether Europe can afford to build such a market, but whether it can afford not to.

Macroeconomic fragility in a fractured union

Despite recent stabilization after the inflation shock of 2022–2023, the EA economy continues to face structural headwinds. The Eurosystem staff projects modest real GDP growth of 0.9% in 2025, gradually increasing to 1.3% by 2027. These figures underscore a sobering reality: Higher defense and green infrastructure outlays are insufficient to offset the negative drag from weak external demand, elevated geopolitical risk premia and supply chain uncertainty. Economists expect core inflation to converge toward the 2% target by 2026, aided by declining energy and input costs, yet with significant double-sided risks. On one hand, wage persistence or fiscal shocks could revive inflationary pressures. On the other, weak domestic demand and euro appreciation could reintroduce disinflationary dynamics, especially in export-dependent economies.

Meanwhile, the EA’s fiscal framework remains bifurcated. National governments continue to operate under divergent debt dynamics, with debt-to-GDP ratios ranging from under 60% (e.g., Estonia 23.6%) to near or over 140% (e.g., Italy 135.3% and Greece 153.6%). Sovereign spreads reflect not just fiscal fundamentals but market segmentation and liquidity premia.

Financial fragmentation remains a persistent theme, especially in longer-dated debt, where the absence of a unified benchmark yield curve leads to suboptimal pricing of risk and capital allocation. The FSAP’s findings on the EA’s banking and non-bank financial institutions point to systemic vulnerabilities: overexposure to domestic sovereigns, limited shock absorption capacity and shallow cross-border investment flows. These are not transient frictions — they are structural flaws in Europe’s financial architecture.

In the absence of a common EA bond that is both scalable and fiscally integrated, Europe lacks the tools to effectively pool sovereign risks, ensure smooth transmission of monetary policy and coordinate countercyclical fiscal responses across member states. As external shocks become more frequent and asymmetric, the current institutional set-up — still reliant on national bond issuance for public spending — becomes increasingly misaligned with the Union’s macroeconomic interdependence.

The erosion of the dollar’s safe asset monopoly

The strategic case for a European safe asset has never been stronger. For decades, US Treasuries served as the global economy’s primary safe asset: deep, liquid and backed by the full faith and credit of a sovereign with unchallenged reserve currency status. But this model is deteriorating. In the United States, publicly held debt is projected to rise from 99% of GDP at the end of 2024 to a record-high 116% by 2034. Beyond that point, debt levels would continue to increase if existing laws and policies remain unchanged. Moody’s downgrade of US sovereign credit, though largely symbolic, triggered a quiet reallocation of reserve portfolios. Global institutional investors began seeking alternatives to Treasuries, either through currency diversification or duration reshaping.

This rebalancing is already visible. In the first half of 2025, non-EA corporates issued over €100 billion (over $116 billion) in euro-denominated bonds. Central banks in Asia and the Middle East have steadily increased euro allocations in their foreign reserves. But this demand is being funneled into a suboptimal market structure. German Bunds — long-denominated, fixed-interest eurobonds issued by the German federal government — remain the EA’s closest counterpart to US Treasuries.

Despite their high credit quality and deep liquidity, Bund issuance is increasingly shaped by domestic fiscal constraints. Germany’s constitutional debt brake has historically limited supply, creating a “Bund scarcity.” However, recent budget reforms and expanded defense and infrastructure spending are beginning to ease this restriction.

Blue bonds as the institutional keystone

Among the various proposals advanced since the sovereign debt crisis, the idea of blue bonds stands out for its political and institutional realism. In their analysis of the Peterson Institute for International Economics, economists Olivier Blanchard and Ángel Ubide envision a capped issuance of up to 25% of EA GDP — approximately €5 trillion ($5.8 trillion) — backed jointly but serviced by national contributions. This issuance volume is sufficient to create a meaningful liquid market, without requiring treaty change or full fiscal union. Crucially, it avoids mutualization of future liabilities — the spreading of potential liability among multiple parties. Member states would commit only to their share of the repayment burden, potentially earmarked from national Value-Added Tax receipts or other stable revenue streams.

Such a design balances moral hazard concerns with the macrofinancial need for integration. Market feedback and academic research suggest that the introduction of senior, jointly issued Eurobonds could significantly narrow sovereign spreads, reduce liquidity premia and enhance the efficiency of collateral use within the Eurosystem. Anchored by robust governance, a sufficiently large and credible Eurobond issuance would deepen market liquidity and improve yield convergence across member states, reinforcing monetary transmission and financial stability.

Participation would be proportional and voluntary. Countries with lower debt-to-GDP ratios could choose smaller allocations. Policymakers could model legal provisions on the United Kingdom’s post-Brexit fiscal settlement to create a rules-based exit mechanism. The governance structure could build on the existing European Stability Mechanism framework or be housed under a new supranational issuance authority.

Blue bonds would thus serve as the keystone in a broader architecture of European strategic autonomy, linking financial stability, fiscal sustainability and geopolitical resilience under a single, scalable framework.

Reinforcing the monetary-fiscal interface

The case for blue bonds becomes even more compelling when viewed through the lens of the European Central Bank’s evolving monetary stance. Following the recent reduction in the deposit facility rate to 2%, monetary policy is approaching a delicate balancing point. Forward guidance indicates that without complementary fiscal support and financial deepening, inflation could fall persistently below target. Structural fragmentation in bond markets exacerbates this risk by weakening the pass-through of policy rates to credit conditions across member states.

Long-term interest rate dynamics provide further evidence. After two decades of declining yields — from more than 6% in the early 2000s to less than zero by 2020 — EA rates underwent a sharp upward correction during the 2021–2023 inflation spike. Since then, the ten-year overnight index swap rate has stabilized around 2.5%, with sovereign spreads narrowing but still exhibiting divergence. Term premium decomposition reveals that risk compensation has normalized, suggesting that markets now perceive reduced uncertainty. Yet the persistence of 100–150 basis point spreads between German and Italian ten-year yields underscores the enduring absence of a common pricing benchmark.

A liquid Eurobond yield curve would enhance monetary policy effectiveness by providing a unified term structure, enabling better communication of forward guidance and reducing the need for ad hoc interventions such as the Transmission Protection Instrument. The blue bond market could also serve as a foundation for developing euro-denominated derivatives, term repos and collateral frameworks that mirror the dollar ecosystem.

In essence, blue bonds are not just a fiscal instrument — they are a monetary tool, a market infrastructure and a vehicle for sovereign risk internalization.

Strategic autonomy through financial sovereignty

The creation of a euro-wide safe asset market aligns directly with the European Union’s broader agenda for strategic autonomy. The concept, often invoked in the context of defense, energy and technology, must also apply to finance. Europe cannot credibly pursue digital sovereignty, green reindustrialization or defense modernization while relying on fragmented national bond markets and external funding channels.

The experience of the Next Generation EU (NGEU) — where €800 billion ($931 billion) in jointly issued bonds stabilized markets, attracted global investors and supported the post-pandemic recovery — offers a powerful precedent. Yet NGEU remains limited in scope and duration. Institutionalizing this model through blue bonds would provide Europe with a permanent instrument to finance European public goods, ranging from cross-border rail to cybersecurity infrastructure.

The proposal does not seek to predetermine the size of the EU budget or shift spending priorities. It merely offers a better financing vehicle. At present, even EU-issued debt trades at a 20–30 basis point premium to Bunds due to illiquidity and lack of scale. A deep and continuous blue bond program would compress this spread, reduce funding costs and increase the attractiveness of euro-denominated assets globally.

The strategic logic is clear. The dollar’s dominance is no longer underpinned by economic fundamentals alone but by institutional depth and trustworthy financial infrastructure. If Europe aspires to global influence and internal cohesion, it must match rhetoric with architecture.

A vanishing policy window

The creation of a euro-wide safe asset is a strategic imperative. Macroeconomic uncertainty, geopolitical fragmentation and financial system vulnerabilities demand a robust, scalable and credible response. The blue bond proposal — market-based, institutionally grounded and politically feasible — offers Europe a way to defragment its sovereign debt market, anchor its monetary policy framework and enhance its international economic stature.

But time is limited. The current global repricing of risk, rising fiscal needs and investor appetite offer a fleeting opportunity. Any delay risks entrenching fragmentation, eroding credibility and forcing Europe into a permanently subordinate position in the global financial hierarchy. As with previous moments in EU history, from the launch of the euro to the NGEU, the challenge is political will, not technical capacity.

[Lee Thompson-Kolar edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.