WE NEED TO TALK ABOUT BUNDS / THE FINANCIAL TIMES

We need to talk about Bunds

A shortage of safe assets in the eurozone is creating market distortions

Kate Allen


© FT montage; Bloomberg; Dreamstime


We need to talk about Bunds and the risk they pose to eurozone markets. No, I’m not joking.

Germany’s insistence on running a balanced budget and a current account surplus leaves no room for an expansion of its government debt — thus limiting the supply of German bonds, or Bunds, which are the eurozone’s safe asset.

The shortage exacerbates the price effect of European Central Bank bond-buying, widening the spread between German yields and those of riskier assets, such as Italy’s bonds.

The 10-year Bund yield reached the giddy heights of 0.8 per cent last year as investors’ minds turned to the end of quantitative easing and the timing of a rate rise. But it has since slipped to 0.1 per cent, pushing the spread against equivalent Italian bond yields to about 2.9 per cent.

The wider spreads are between ostensibly equal member states. The more volatile they are, and the more investors focus on them as a barometer of political risk, the more political the sovereign debt markets become.

EU budget rules aim to ward off excessive surpluses as much as deficits. They should mitigate against parsimony just as much as they are used against countries such as Italy for profligacy.

It is all very well to castigate Italy for its big debt burden, but not enough attention is paid to what happens when countries are not selling enough debt.

The euro was created “as a means of strengthening the political bonds between [European nations]”, according to the European Commission. Deliberately under-borrowing on your fiscal capacity, leaving the continent’s banks and pension funds with a shortage of safe assets, hardly helps fulfil that ambition.

Germany has in recent years run record budget surpluses and the world’s largest trade surplus, which last year led French president Emmanuel Macron to accuse his neighbour of “fetishising” surpluses.

The shortage of Bunds is arguably one of the drivers of exuberance in areas such as real estate. Investors need to put their money somewhere and there is not enough of what they actually want to buy so they are forced into substitutes which then rapidly become overloaded and suffer price bubbles.

It is rare to hear an argument in favour of increasing a country’s indebtedness, but the evolution of the bloc’s capital markets should also be on Germany’s agenda.

A way around Germany’s budget policies would be to create pan-eurozone debt instruments backed by multiple countries, but Germany is unwilling to tolerate mutualisation of debt. The eurozone already faces democratic challenges in pursuing further integration, so it is hard to blame it for that.

But that constrains the development of Europe’s capital markets because of the safe assets shortage.