Debt Riddle

The enduring charm of German bonds

Carsten Lehr
Sells them like hotcakes: Germany's bond meister Carsten Lehr. Source: Bert Bostelmann for Handelsblatt

At first glance, it makes little sense to lend someone money and have to pay for the privilege. But Germany’s creditworthiness is so rock-solid that investors are willing to pay negative interest rates to own its bonds, and that’s unlikely to change, according to a senior finance official in the German government.

For most of 2017 the yield, or return on investment, for German Bunds, or bonds with a maturity of up to seven years, has been below zero. Incredibly, for two-year bonds, the yield has been stuck in negative territory since the summer of 2014. Currently, it is hovering around minus 0.76 percent.

Granted, as returns on German debt melted away, some demand from institutional investors also went south. But during the euro-debt crisis, jittery investors, seeking a safe haven, flocked to German bonds even as yields dipped below zero. The downward trend continued after March 2015, when the European Central Bank launched its regular purchases of euro-zone debt to jump-start economic growth in the region.

The Bundesbank, Germany’s central bank, is authorized to buy German debt under the ECB’s €2.55 trillion ($2.96 trillion) bond purchase program (and is, in fact, the biggest single buyer of Bunds). However, others invest in German debt for very different reasons, noted Carsten Lehr, co-head of the Finance Agency charged with selling and managing German government debt.

Central banks from countries bordering the euro zone, such as Switzerland, Russia or Denmark, have significantly increased their share of German government bonds in recent years, including ones with negative yields, Mr. Lehr told Handelsblatt. Asian central banks also stepped up their purchases of German debt to maintain their euro currency holdings.

“The Bundesbank won’t drop out as a buyer overnight.”

Carsten Lehr, co-head of the Finance Agency, on the central bank's Bund purchases

Mr. Lehr said he assumed some of these countries were buying euro bonds to prevent their currencies from appreciating too much, and to boost their exports. “Yields don’t matter in this respect,” he said. In this instance, German bonds are popular “because of their excellent creditworthiness and good tradability.”

The official said trading in German federal bonds increased to €2.6 billion in the first half of 2017 – a steep 20 percent rise over the like period in any of the previous three years. He said he wasn’t worried about the upcoming reduction in ECB bond-buying. Last month, the central bank announced that starting in January, it would halve its monthly purchases of these euro-zone securities to €30 billion.

“We had enough demand for federal securities before the Bundesbank bought bonds on behalf of the ECB,” he said. “Besides, the Bundesbank won’t drop out as a buyer overnight.”

He also referred to the ECB’s decision, announced last month, that it would extend its bond purchases by nine months to September 2018 and would likely reinvest the money from maturing government bonds into federal debt. Although dwarfed by the ECB’s ongoing stimulus program, the amount of reinvestment will still be considerable. “In the coming years it will be between €30 and 40 billion per year,” Mr. Lehr said.

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Germany’s refinancing costs are likely to remain low thanks to the ECB’s enduring low-interest rate policy, but also because the Finance Agency’s bond portfolio gives it ample room to maneuver, he said. “We have many higher-interest bonds in our portfolio which will mature over time,” noted the 52-year-old, who will leave his post at the end of the year. “We can refinance those with lower interest rates. So in the foreseeable future, we don’t expect significantly higher interest costs for the entire portfolio.”

He said the ECB’s decision to scale back its bond purchases wouldn’t trigger unrest in bond markets. “On the contrary, most investors want interest rates to gradually rise again and the market to find its way back to normal,” Mr. Lehr said. That particularly applies to large companies and pension funds that pay attention to yields, and which are buying fewer federal bonds than they used to.

Andrea Cünnen covers the bond markets for Handelsblatt. David Crossland and Jeremy Gray adapted this story for Handelsblatt Global. To contact the author: cuennen@handelsblatt.com.

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