A record net supply of 930 billion euros in European government bonds is projected for 2026. While approximately 700 billion euros of demand is expected from price-insensitive buyers, the remaining 230 billion euros will need to be absorbed by price-sensitive investors. This dynamic could push eurozone government bond yields higher. The trend of de-dollarization and European fiscal risks will collectively influence long-term capital flows.
The supply volume for 2026 is set to exceed price-insensitive demand. Markets successfully absorbed the first wave of issuance in January, but analysis indicates that interest rates may need to rise further. In 2026, net supply of European government bonds will reach a historic high of 930 billion euros. Government issuance will account for about 550 billion euros, while the European Central Bank's quantitative tightening (QT) program is expected to add another 380 billion euros of supply to the market. A record volume of government bonds is anticipated to enter the market in 2026.
Demand is categorized as either price-sensitive or price-insensitive. Price-sensitive buyers typically require higher yields before they are willing to enter the market. In contrast, price-insensitive demand is often driven by regulatory frameworks. For instance, demand from banks and pension funds is closely tied to asset growth and is likely to be relatively unaffected by price. On the other hand, investment funds, which are less constrained by regulation, are more likely to have demand driven by yield levels. A bottom-up sectoral analysis reveals a government bond demand shortfall of 230 billion euros.
Price-insensitive demand for government bonds is estimated at around 700 billion euros, meaning the remaining 220 billion euros must be absorbed by more price-sensitive buyers. Banks will continue to be the largest price-insensitive buyers in the eurozone as they need to replace outflows of central bank reserves. However, to attract additional demand from more price-sensitive investors like investment funds, yields may need to become more attractive. This supports the view that the yield on the 10-year German government bond will continue to trend gradually higher, reaching 3.1% by the end of 2026. The following analysis delves into the demand drivers for each sector.
Banks continue to play a crucial role in absorbing government bonds. Recent data shows banks purchase approximately 340 billion euros of government bonds annually and will remain the largest buyers in the eurozone. Regulatory requirements mandate that banks hold high-quality liquid assets (HQLA) to cover liquidity outflows, thereby increasing demand for government bonds. As QT leads to the withdrawal of central bank reserves from the system, banks must supplement their liquidity portfolios with other HQLA to maintain a constant liquidity coverage ratio (LCR). Government bonds constitute about 55% of non-reserve HQLA. Therefore, replacing 380 billion euros in reserves would generate demand for roughly 210 billion euros in government bonds. Banks purchase government bonds as central bank reserves decline and their assets grow.
The amount of HQLA required to maintain a stable LCR also increases as balance sheets expand. Over the long term, banks' HQLA has stabilized at around 20% of total assets. By projecting asset growth and changes in central bank reserves, demand for government bonds can be modeled. In recent years, asset growth has been about 1.1 trillion euros annually, translating to new demand for government bonds of 120 billion euros. Total demand from eurozone banks, estimated at 330 billion euros, will help absorb the substantial supply, especially as these purchases are relatively price-insensitive. Demand for government bonds stems from regulatory constraints and the relatively limited pool of HQLA alternatives.
Price-insensitive demand from financial investors is estimated by extrapolating asset growth trends.
Insurance companies are another major investor group but may seek a steeper yield curve to increase their purchases. The insurance sector increased its buying again in 2025, with recent data showing annual net purchases of 49 billion euros. Before 2021, government bonds made up about 20% of assets, but this share is now only 15%. This implies significant potential for increase, but data suggests insurers are price-sensitive buyers. Their government bond purchases appear correlated with the steepness of the 5s30s yield curve. Therefore, while baseline demand for 2026 is projected at 40 billion euros, higher yields may be needed to attract additional marginal buying. Insurers might seek a steeper curve to further stimulate demand.
Demand from pension funds is expected to decrease significantly due to the ongoing transition of the Dutch pension system, with the sector even forecast to be a net seller in 2026. The relationship between assets and government bond holdings has been very stable, at about 15% of assets, which would typically generate additional demand of around 20 billion euros. However, Dutch pension reforms have triggered a structural decline in government bond demand, estimated at about 100 billion euros. A large portion of this may not occur until 2027, but for 2026, Dutch pension funds are expected to be net sellers of approximately 30 billion euros. Consequently, total demand will be reduced by about 10 billion euros. That said, pension funds can be quite flexible in increasing their government bond purchases, but this would certainly require attractive yields compared to other asset classes.
The largest potential source of demand may come from investment funds, but these funds are also highly price-sensitive. The positive correlation between trading volumes and the 10-year swap rate indicates that investment funds buy when rates are high and sell when they are low. In recent years, holdings of government debt securities have stabilized at around 5% of assets. Based on this assumption, a year with 5% asset growth would generate additional government bond demand of 50 billion euros. This could depend more on stock prices, as equities constitute a large portion of fund assets. Again, investment funds might be inclined to shift more towards government bonds if yields rise to sufficiently high levels. Investment funds are potential large buyers but are sensitive to yield levels.
Buyers from other countries could help, but fiscal concerns remain a risk. Strong demand from foreign investors may persist, as current holdings remain well below pre-quantitative easing (QE) levels. Before QE, foreign investors held over 27% of the total outstanding debt, significantly higher than the current 24%. Recent data shows annual demand of 245 billion euros, second only to eurozone banks. Forecasting foreign investor demand is more challenging due to the diversity of the investor base. Official foreign reserve managers are key buyers of eurozone government bonds and are relatively price-insensitive. As the U.S. dollar's global standing faces challenges, demand for euro-denominated assets is expected to increase. In the assumptions for price-insensitive demand, only the latest available flow data is referenced.
Other foreign investors, such as private financial firms, are likely more price-sensitive buyers. When the ECB was heavily purchasing government bonds during QE, yields were suppressed, crowding out foreign buyers. Conversely, in the current QT phase, rising yields are attracting foreign investors back. Investors from other countries help absorb the additional supply created by quantitative tightening.
With QT stabilizing at around 350 billion euros annually, foreign buyers are expected to remain a significant source of demand in 2026. However, yields may need to continue rising to sustain these inflows.
During the Asian trading session, the euro traded near 1.1905 against the U.S. dollar, following a significant rise in the previous session due to a sharp decline in the dollar. Speculation about "de-dollarization" suggests potential for an unexpected rise in demand for European assets as an alternative. As the United States fails to address its fiscal issues, European debt could appear increasingly attractive to foreign investors seeking safety. On the other hand, parts of Europe also face fiscal challenges, and any concerns about another eurozone sovereign debt crisis could quickly deter foreign investors.