Bond Market Favoring Obama Over Merkel as Euro Threatens Germany as Haven
Germany is being penalized in the global bond market as European leaders fail to show investors they have a plan that will succeed in curing the region’s most- indebted economies.
Yields on 10-year bunds are poised to rise above comparable maturity U.S. Treasuries for the first time since June 2009 on concern Germany will assume a greater burden to support the European Monetary Union. The difference narrowed to as little as 7 basis points on Nov. 29, from 90 basis points in April as the 85 billion-euro ($114 billion) aid package for Ireland failed to stem concern that Europe’s debt crisis will broaden.
German borrowing costs have risen relative to the U.S. as Chancellor Angela Merkel pushed to limit spending on bailouts and European Central Bank President Jean-Claude Trichet disappointed investors when he didn’t announce new measures to spur a recovery. In the U.S., President Barack Obama has run consecutive $1.4 trillion budget deficits to boost the economy and prevent the financial and auto industries from collapsing.
“The ECB and the policy makers in Europe didn’t learn from the experience of the United States that you have to address these problems aggressively, quickly and effectively, and if you don’t, it’s only going to get worse,” said James Kochan, chief fixed-income strategist at Wells Fargo Funds Management, which oversees $175.6 billion of bonds in Menomonee Falls, Wisconsin. Investors have been “frightened out of the euro-currency markets, and they’re buying Treasuries again,” he said in a Nov. 30 interview.
Bunds are underperforming Treasuries even though Germany’s economy is growing faster and its debt is lower than in the U.S. German gross domestic product may expand 3.5 percent in 2010 with a budget deficit that is 3.75 percent of GDP, according to the median economist forecasts in Bloomberg surveys. The U.S. will grow 2.7 percent, with a budget deficit projected at 9 percent of GDP.
Treasuries have returned 0.95 percent on average since the end of June, compared with a loss of 0.5 percent for bunds, according to Bank of America Merrill Lynch indexes.
The gap in yields between bunds and Treasuries has narrowed from 45 basis points, or 0.45 percentage point, on Aug. 27, when Federal Reserve Chairman Ben S. Bernanke said during a Jackson Hole, Wyoming, symposium that the central bank would provide additional stimulus as needed.
Trichet told reporters on Dec. 2 after leaving interest rates unchanged that the central bank will delay the withdrawal of emergency funding. Trichet nevertheless refused to say whether the ECB will boost or broaden its bond purchases and said the central bank will keep sterilizing them, unlike similar programs at the Federal Reserve and Bank of England.
“Further, decisive, policy action is needed to prevent further escalation of the crisis,” economists at Barclays Plc in London wrote in a research report dated Dec. 3.
The median estimate of more than 19 strategists and economists surveyed by Bloomberg is for bund yields to rise above Treasuries next quarter and stay there through 2011.
The yield on the benchmark 2.5 percent German note due January 2021 climbed 12 basis points last week to 2.86 percent as the price of the security fell 1.04, or 10.40 euros per 1,000-euro face amount, to 96.89. The yield closed at 2.85 percent in London. The 2.625 percent U.S. Treasury due November 2020 jumped 14 basis points last week to 3.01 percent as its price dropped 1 5/32, or $11.56 per $1,000 face value, to 96 23/32. The 10-year note yielded 2.94 percent at 3:02 p.m. in New York, according to BGCantor Market Data.
Bunds have yielded 18 basis points on average less than 10- year Treasuries since 1990, according to data compiled by Bloomberg. The difference reached a record 123 in October 2005.
U.S. yields last fell below those in Germany in November 2007 as the financial crisis that began with subprime mortgages began to spread, freezing credit markets and driving America’s economy into recession.
Treasury yields remained below bunds until June 2009, when signs of a recovery spurred investors to buy riskier securities such as stocks and corporate bonds. At the same time, Treasury sales rose to a record to pay for $862 billion in fiscal stimulus and the $700 billion Troubled Asset Recovery Program, pushing the budget deficit to an all-time high.
Yields on 10-year Treasuries would be eight to 10 basis points higher if it wasn’t for increasing concerns about smaller European economies, such as Ireland, Portugal and Spain, Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee, wrote in a note to clients published Nov. 29. The rise in bond yields in those countries has spread to Belgium and Italy, he said.
“As we’ve learned, it’s not all about math and analysis,” Vogel said in telephone interview. “It’s political will; it’s leadership; it’s the direction things are going.”
The response of European policy makers is piecemeal and insufficient to stem the spread of contagion to healthier sovereign credits, said Scott Mather, a managing director who helps oversee global debt at Pacific Investment Management Co. The Newport Beach, California-based firm manages about $1.2 trillion, including the biggest bond fund.
“The additional liabilities accumulate for Germany with each and every bail-out,” Mather said in an interview last week. “Near term the major issue is who’s next in Europe. Portugal’s almost a foregone conclusion. It seems they’re constantly two, three, four steps behind the market, and so they’re always in crisis-response mode and not proactive,” he said in reference to policy makers.
The adoption of the euro by most of western Europe in 1999 helped Germany by lowering barriers to exports and providing a more easily traded currency, according to Brian Kim, a currency strategist at UBS AG in Stamford, Connecticut. It also cut borrowing costs, fueling the indebtedness that presaged the current crisis, he said.
Germany’s trade surplus has risen to 16.8 billion euros from about 5 billion euros at the time of the creation of the common currency. The difference in yields between German and Irish 10-year debt shrank to less than 50 basis points in 1999 from about 180 in 1994 and about 300 in 1992, according to data compiled by Bloomberg. The gap reached 668 last week.
Conflicting policies in Germany and Greece and Portugal, which have trade deficits, “hamstrings the ability to use the currency as a policy tool,” Kim said in a Dec. 3 interview. “The peripherals would love to be able to devalue currency at a time like this,” but can’t because it would spark faster inflation in Germany, he said.
The strategist forecasts the euro will fall in the next six months to between $1.20 and $1.25 as policy makers continue with country-by-country solutions to the crisis. The euro weakened to $1.2969 on Nov. 30, from last month’s high of $1.4282 on Nov. 4, before ending last week at $1.3414.
Rising concern about Germany was evident in the 4.76 billion euro auction of 10-year bunds on Nov. 24, according to William O’Donnell, head U.S. government bond strategist in Stamford, Connecticut, at Royal Bank of Scotland Group Plc. The offering was originally slated at 6 billion and wound up generating 5.91 billion of bids.
When concerns about Greece’s finances first surfaced a year ago, it took until May for the ECB to produce a $1 trillion aid package for countries with sovereign debt troubles, which by then had expanded to Portugal and Spain.
“The ECB has a completely different philosophy about how they intervene,” said Dominic Konstam, head of interest-rate strategy at Deutsche Bank AG in New York. “The U.S. has always been about keeping liquidity as easy as possible, and the ECB has been more careful about trying to set monetary policy for the euro zone.”
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