Bond Buying

World Turmoil Makes German Bonds More Attractive Despite Poor Yields

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Phones are ringing for traders as demand for German government bonds grow.
  • Why it matters

    Why it matters

    A weakening economy and conflicts in Russia, Ukraine and Middle East are driving investors in Germany into the safety of bonds, despite their low yields.

  • Facts

    Facts

    • Investors pay the German government to lend it short-term money, as yields have plunged to below zero.
    • Still bonds have become more attractive because of political woes in neighboring nations and beyond.
    • The combination of low bond yields and low economic growth is arousing fear among investors.
  • Audio

    Audio

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Analysts recently predicted the threshold would be breached, and on Thursday it happened:  The rate of return on 10-year federal bonds fell below 1 percent for the first time in Germany’s history. It reached a low of 0.998 percent and was just over 1 percent by late afternoon.

At the same time, the price of the Bund-Future – a futures contract enabling investors to speculate on the growth of bond yields – exceeded 150 percent for the first time.

Bonds with returns mirroring the development of share prices have been in huge demand by investors in recent weeks. This is due to increased fears of crisis and war in and around Russia, Ukraine and the Middle East.

Add to that the poor economic data. All this combined is driving investors to buy federal bonds, which are considered foolproof in terms of guaranteed repayment. They also have infinite liquidity; even at narrow trading margins, buyers and sellers are ever-present. That is why many funds include federal bonds as a substitute for cash in their portfolios.

Bonds are considered foolproof and also have infinite liquidity.

It has reached the point where investors actually pay a fee of sorts to the state when lending money to Germany with short maturity. The reason: the yield on federal bonds that mature in two years has slipped back below zero. It recently plunged to minus 0.02 percent, the lowest rate since May 2013.

The European Central Bank also plays an important role in the complex state of affairs. According to data published Thursday, economic growth in the second quarter dropped  in Germany by a surprising 0.2 percent from the previous quarter and is stagnating across the euro zone. This raises hopes of further aid from the ECB – all the more valid as inflation in the euro zone is at 0.4 percent.

“This improves the chances of bond purchases from the ECB,” said Alessandro Giansanti, an interest rate analyst with the Dutch financial institution ING. Hendrik Lodde, an analyst at Germany’s DZ Bank, believes that is only possible if the euro zone slips into deflation, which he doubts will happen. However, according to Mr. Lodde, the ECB would indeed resort to bond purchases in the event of deflation, because it would then have run out of conventional monetary policy options.

The base rate is already at an all-time low of 0.15 percent, interest rates on deposits are negative, and the ECB will also start granting new long-term loans in September. However, the ECB will probably wait and see the effects of these loans over the period of a year or so before taking further measures.

Nevertheless, the combination of low bond yields and low economic growth is arousing fear among investors.

“It feels a bit like a Japanese scenario,” said Christian Kind, the director of investment strategy at the fund company Frankfurt Trust. Starting in the early 1990s, Japan was caught in deflation for almost two decades.

Economic growth in the second quarter dropped by a surprisingly 0.2 percent from the previous quarter.

Despite these concerns, German shares continued to recover on Thursday. According to analysts at the French banking Group Société Générale, it is because many investors expect interest rates to remain low for longer than expected, not just in the euro zone but also in the United States, where disappointing retail sales figures were released on Wednesday.

The German stock index increased by 0.3 percent to 9,225, having previously been as high as 9,266. The EURO STOXX 50, an index of euro zone stocks, gained 0.1 percent.

Among the DAX companies with figures to report, only the German industrial company ThyssenKrupp, with a higher net profit than expected and a more optimistic outlook, could score with investors. Its share prices slightly increased, whereas the German electric utilities company RWE reported a fall of one-third in its operating profit, making its shares among the biggest losers on the DAX index. The agricultural chemical company K+S also earned less than it did in the last quarter, although it exceeded analysts’ predictions. The company’s stock closed with a slight increase.

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