HEARD ON THE STREET
June 6, 2012
German Bunds Could Go South
By THOROLD BARKER
As the euro zone's future hangs in the balance, everyone is jumping on the
bund wagon. But German government debt is riskier than some investors
imagine.
A flight to safety has pushed the yield on government bonds issued by Germany, the euro zone's largest and strongest economy, to historic lows. The yield on the 10-year bond, known as a bund, is about 1.20%, down from 2.95% at the start of 2011 and 1.92% at the start of this year. In contrast, Spanish bond yields have risen this year to about 6.30% from 5.23%, and the country's budget minister said Tuesday that the government had effectively lost access to capital markets.
The bull case for bunds is simple. If southern European countries like Portugal, Spain and Greece continue to struggle with weak economies and rising debt burdens, Germany will remain the safest place for individuals, companies and other institutions to park their euros.
.
And if the worst-case scenario plays out with the single currency breaking apart, those investors will at least end up with deutsche marks rather than pesetas. So, for those who need to have their money in euros and are focused on a return of capital, rather than a return on capital, bunds are the place to be.
There is, though, a bear case for bunds. For starters, a euro-zone breakup would result in huge economic dislocations, even for Germany. Although the deutsche mark would be the strongest of a new set of currencies, the economic cost of a euro disintegration could hammer Germany's finances. That could lead investors to become more leery of its debt and run for Treasurys instead.
As Europe tries to avoid that outcome, pressure will build for Germany to backstop weaker countries. The most likely way would be through some form of banking union in the euro zone or even the issuance of euro bonds underwritten by all member states. Either of those moves could prove a huge financial commitment for Germany.
But such costs also would be felt by Germany over many years, as opposed to the swift and immediate pain from a euro breakup. Given that politicians usually try to defer the pain, the risk that Germany eventually gives ground and has its balance sheet ever more polluted by southern Europe is real.
..
An agreement from Germany to back more of the euro zone's liabilities would help settle nerves across Europe, taking the edge off today's flight to safety and causing German yields to rise. But it also would damage Germany's own credit-worthiness, again potentially pushing up its borrowing costs from ultralow levels while those of other countries fell.
.
.If Chancellor Angela Merkel blinks, bunds could pay the price.
A flight to safety has pushed the yield on government bonds issued by Germany, the euro zone's largest and strongest economy, to historic lows. The yield on the 10-year bond, known as a bund, is about 1.20%, down from 2.95% at the start of 2011 and 1.92% at the start of this year. In contrast, Spanish bond yields have risen this year to about 6.30% from 5.23%, and the country's budget minister said Tuesday that the government had effectively lost access to capital markets.
The bull case for bunds is simple. If southern European countries like Portugal, Spain and Greece continue to struggle with weak economies and rising debt burdens, Germany will remain the safest place for individuals, companies and other institutions to park their euros.
.
And if the worst-case scenario plays out with the single currency breaking apart, those investors will at least end up with deutsche marks rather than pesetas. So, for those who need to have their money in euros and are focused on a return of capital, rather than a return on capital, bunds are the place to be.
There is, though, a bear case for bunds. For starters, a euro-zone breakup would result in huge economic dislocations, even for Germany. Although the deutsche mark would be the strongest of a new set of currencies, the economic cost of a euro disintegration could hammer Germany's finances. That could lead investors to become more leery of its debt and run for Treasurys instead.
As Europe tries to avoid that outcome, pressure will build for Germany to backstop weaker countries. The most likely way would be through some form of banking union in the euro zone or even the issuance of euro bonds underwritten by all member states. Either of those moves could prove a huge financial commitment for Germany.
But such costs also would be felt by Germany over many years, as opposed to the swift and immediate pain from a euro breakup. Given that politicians usually try to defer the pain, the risk that Germany eventually gives ground and has its balance sheet ever more polluted by southern Europe is real.
..
An agreement from Germany to back more of the euro zone's liabilities would help settle nerves across Europe, taking the edge off today's flight to safety and causing German yields to rise. But it also would damage Germany's own credit-worthiness, again potentially pushing up its borrowing costs from ultralow levels while those of other countries fell.
.
.If Chancellor Angela Merkel blinks, bunds could pay the price.
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