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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?

Are bunds betting on a Deutsche Mark return?

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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7 comments so far. Why not have your say?

Graham D-C

Jun 19, 2012 at 08:18

Germany opting out of the eurozone wuold be hugely popular with its people and virtually guarantee Merkel and her party' retaining political power for years to come

As things stand, at the very least Germans expect Merkel to resist all calls for her to weaken her position of insisting that Greece fulfills the austerity agreement. Failure to do so would only increase the potential for a contagion effect. The most powerful argument against bailing out Greece is that it will never be able to repay its debts. If Greece leaves, it wil serve notice on the likes of countries such as Portugal, Spain and Italy, that unless they get their finances in order, they too will face the same fate. It will only take a second country to seek a bail out for the eurozone to collapse.

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William Bishop

Jun 19, 2012 at 10:14

While I agree that a return to the deutschmark would be politically very popular in Germany, minds might eventually change when it became apparent that the strength of the currency was pricing Germany out of a lot of its export markets. Thus Angela Merkel is likely to try to go on doing just enough to prevent the euro from disintegrating while not offending the conservative financial instincts of her electorate. That tightrope is getting more stretched, but may not yet be ready to break.

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an elder one

Jun 19, 2012 at 10:50

Germany are a very disciplined nation, they would manage a stronger dmark; for the good of all - not least the uk; who wants German hegemony? - they should drop the euro millstone and settle accounts; politics is the problem not finance.

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Graham D-C

Jun 19, 2012 at 12:55

William .

If by reverting to the DM, Germany found the prices of its products less competitive, it would go someway to help the less efficient countries to gain a larger share of exports within in the EU and beyond. A small price for Germany to be pay in lieu of being saddled for a generation propping up a debt ridden country like Greece.

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William Bishop

Jun 19, 2012 at 18:03

Graham D-C. Your point is valid as regards exporting within Europe, but I think that Germany would also be concerned at losing market share in places like China against competitors from the US, Japan, Korea, etc., thus might not see it as "a small price to pay"

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Jun 19, 2012 at 18:44

Graham, disagree, not a generation, but generations. It is part of the Greek/Italian phsyche to dodge tax.

For the Greeks, if they succeed now, they hold the whip hand about their debt and unrealistic local requirements, "do it or we will default....."

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an elder one

Jun 19, 2012 at 19:31

Whatever the nature of challenges in the global market, it's something we all have to face and Germany in particular I feel have the wherewithall to handle it (better than the UK daresay), what they don't need I reckon is the likes of Greek hangers-on bleeding them dry.

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