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Are bunds betting on a Deutsche Mark return?
The price of German government bonds has soared as the eurozone crisis has worsened. Is there more to this safe haven than meets the eye?
The indomitable rise of German bund prices shows few signs of abating as yields fell close to record lows on fears about the Spanish banking sector last week.
The gap between dividend yields on the Euro Stoxx 50 and German government paper also reached an all-time high at 4% versus 1.2%, a spread of around 280 basis points.
But is it really all down to the perception of Germany as a safe haven, or is there more to the trade than meets the eye?
Even given the exceptional circumstances we are in, it is still staggering that Germany was able to auction off €4.56 billion of bonds carrying a 0% coupon last month, another first in a rapid succession of many.
Some investors, however, believe it is not just Germany’s safe haven status that is alluring, more the possibility that the powerhouse will exit the single currency and return to the Deutsche Mark. Such a move, it is anticipated, would lead to a strong revaluation, enabling bondholders to enjoy bumper returns.
‘German bunds are basically being seen as a warrant on the Deutsche Mark,’ said one fund manager, who did not want to be named.
Although the Germans would understandably be minded to relaunch their own currency at a favourable rate to their own interests rather than those of investors, market forces would surely see it rise in value both quickly and strongly.
However, that might be jumping the gun as there are probably more investors banking on the euro surviving, in which case bund prices are seen as unsustainable.
Ian Spreadbury, manager of the Fidelity Moneybuilder Income fund, a star pick of Citywire Selection, has 15% of his fund shorting (ie betting their price will fall) the government bonds of various European countries, including German bunds.
Spreadbury believes that Germany will eventually be forced to accept some kind of eurobond, backed by its economic strength, as the price to pay to preserve the eurozone. This massive financial commitment will weaken its credit rating, thus reducing the price of its bonds and causing their yields to rise. (Yields move in inverse proportion to prices as our recently Lolly Investor Programme on how bonds work explained).
Speaking to journalists last week he said: 'I think the odds are in favour of the euro hanging together and policymakers implementing a eurobond, it may take a while for this to happen but eventually Germany will recognise its in their best interests to pick up the tab. When this occurs German yields will rise, which is why I happy to put the short position on.'
Bill Gross, manager of the Pimco GIS Total Return Bond fund, agrees. Speaking on Bloomberg TV Gross said: I would be leery of German bunds simply because there are a few scenarios in which they can do well. If they will do well, if Germany leaves the zone and some way or another move back to the deutsche mark opposed to the euro and pay off obligations in euros and benefit because of it. Otherwise, increasingly, as we have seen over the weekend in terms of Greece, this kick-the-can environment adds liabilities to the German balance sheet day after day.'
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by David Kempton on May 24, 2016 at 17:15