Will they keep going up?

German bunds are Germany’s form of sovereign debt issuance Photo: canadastock/Shutterstock

German bunds soared over the year as economic uncertainty followed unprecedented government borrowing.

With Russia’s invasion of Ukraine forcing more borrowing, will Bunds continue to find enough buyers to push rates higher?

What are German Bunds?

German bunds are Germany’s form of sovereign debt issuance, equivalent to US Treasuries or British gilts.

The German state issues levees to fund spending on things like roads and schools. They are very attractive because refuge assets.

Bunds see their rates rise in response to several factors, but generally those associated with periods of decline in the broader economy. They may increase in response to volatile market risk such as high levels of inflation or a declining stock market, or following a rise interest rate.

Holding bunds is considered a safe haven investment, due to their low risk and high probability of return. However, bunds carry interest rate risk as rising German bond yields decrease the value of bonds held by investors. Right now (November 11) they are rising faster than inflation.

Generally, interest in Bunds appreciates as their maturity lengthens, reflecting the apparent risk of holding assets longer.

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German Bunds: Rising Prices and Interest Rates

If bunds are rising due to market risk, it is no surprise to see German bond yields rising in the current environment.

Inflation in Germany has risen rapidly as the country battles the fallout from stalled supply chains following the lifting of Covid-19 restrictions and the Russian-Ukrainian conflict.

The Consumer price index (CPI) rose 10.4% in October, compared to 10% in September. Meanwhile, the harmonized index of consumer prices rose 11.6%, beating the consensus of 10.9% among analysts polled by Reuters.

Germany, more than several of its eurozone compatriots, was heavily dependent on Russian energy before Russia invaded Ukraine – 55% of the country’s gas imports in 2021 came from Russia, according to the World Economic Forum (WEF). By June 2022, that figure had fallen to 26%.

Inevitably, this added to a steep increase in costs. Energy price inflation hit 43.9% in October. It was 10.8% in the same month of the previous year. According to analysts, this also has an impact on German bonds.

“Germany’s skyrocketing inflation trend is creating an earthquake for the Bund market,” Capital.com analyst Piero Cingari wrote in a note.

Indeed, inflation forces the European Central Bank (ECB) – which has a target CPI of 2% – to raise interest rates with warmongering intentaffecting the borrowing of eurozone member states such as Germany.

The ECB raised its deposit facility by 75 basis points (basis points) at 1.5% in Octoberwhich followed a previous 75 bps increase from zero in September. The bank is preparing the markets for the idea of ​​these hikes becoming commonplace in the future, with ECB President Christine Lagarde saying the bank had to do what was necessary to control the surge in prices.

The German 10-year bond seems to be reacting to the rises, rising from 0.77% in early August to 2% on November 10. Since the start of the year, the yield has jumped from negative territory by more than 200 basis points.

German 10-Year Bond Chart

Source: Trade Economics

Past performance is not a reliable indicator of future results

In this unstable economic climate, bunds have become increasingly popular as a safe-haven asset.

Germany 40 (DAX) – which represents 40 of the largest and most liquid German companies trading on the Frankfurt Stock Exchange – has fallen 11.7% since the start of the year (YTD) as investors avoid corporate risks associated with spikes in inflation and rising interest rates.

The German currency, the euro (USD), has fallen against the dollar this year, with the greenback seen as another safe-haven asset and boosted by the US Federal Reserve (fed) increasingly hawkish stance on rates.

Some analysts believe this has made the dykes more attractive than usual. In a note from last month, ING wrote

“The geopolitical context continues to support the demand for safe haven Bunds. Furthermore, the same ECB that walks away from the bond market can also raise systemic concerns, whereas in the Eurozone the concern is focused on peripheral bond markets.

“With record high implied market volatility and short-term rates still trending higher as central banks tighten policy reins, rate directionality is another factor that may well keep Bund ASWs elevated.”

Germany also faces a large budget deficit linked both to the Covid-19 stimulus and to measures taken since the start of Russia’s campaign against Ukraine.

The country recorded a 189 billion euros deficit in 2020, its biggest since German reunification in 1990, as it filled public coffers to cope with aggressive lockdowns. This has fallen to a still substantial level 132 billion euros in 2021.

Germany recorded a deficit of 13 billion euros in the first half of 2022after accumulating a deficit of 75.6 billion euros in the first half of 2021. As a result, an increasing number of bonds were made available by the German government, which may have helped to keep rates lower than they otherwise would be.

This is set to intensify, with Germany planning to double its borrowing to 45 billion euros in 2023 to combat the effects of an energy deficit, sources said. Bloomberg.

Piero Cingari noted that this could affect the outlook for the bond market:

“The German government will have to issue more bunds in order to finance its budget deficit next year and to cover its growing energy expenditure. The additional supply of bunds will have to be absorbed mainly by investors, since the ECB will no longer have a program quantitative easing and could switch to a quantitative tightening program.

Analyst opinions and projections

The bond market forecast for Germany straddles the continued appeal of debt as a safe-haven asset and the government’s desire to continue injecting new supply into the market.

“Bunds are still one of the most liquid assets in the world, but Germany’s fiscal and external position is deteriorating, and the upward trend in inflation is not over yet, so investors will want to higher returns on this asset,” Cingari said.

“Clearly, the possibility of a European recession is increasing the demand for safe-haven assets, and Bunds could benefit from this trend. However, if inflation remains high and the government needs to spend more money to contain household energy spending, this will not create a bull market for Bunds, even in a recession.

According Global government bondsthe German 10-year bond is expected to reach 2.57% by the end of March 2023, up 56 basis points from current levels.

Meanwhile, Trade economy expect the 10-year yield to hit 2.95% in 12 months, after hitting 2.22% at the end of this quarter.


What are German Bunds?

This is the German form of sovereign debt issuance, equivalent to US Treasury bonds or UK gilts.

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James R. Rhodes