Germany With Zero Yield Beats U.S. Since Crisis: Riskless Return
German bunds have proven better than Treasuries since the start of the global financial crisis five years ago as U.S. stimulus measures and record deficits keep investors wary of a resurgence of inflation.
The BLOOMBERG RISKLESS RETURN RANKING shows bunds are the best performing sovereign securities among Group of Seven nations since June of 2007, returning 8.4 percent after adjusting for volatility and comparing returns in local currencies. Treasuries, traditionally sought by investors worldwide during times of turmoil, have gained 7.4 percent during the same period, also lagging behind Canadian, French and U.K. debt on a risk-adjusted basis.
Investors are willing to own bunds at zero yields as Europe’s debt crisis reduced the supply of the safest assets, Chancellor Angela Merkel cuts debt and the Bundesbank demands that measures taken by the European Central Bank to stem the region’s debt crisis don’t add to money supply. U.S. government debt topped $16 trillion in August for the first time, and Moody’s Investors Service said yesterday it may join Standard & Poor’s in downgrading the U.S.’s credit rating. Investors anticipate the Federal Reserve will add stimulus as soon as tomorrow.
“The difference between the U.S. and Germany is the relative explosion of the U.S. fiscal policy that doesn’t seem to have a solution,” said Jürgen Odenius, chief economist at Prudential Financial Inc.’s Prudential Fixed Income unit in Newark, New Jersey, which oversees $335 billion in bonds. “Germany’s fiscal position is in great shape.”
Germany’s budget will be close to balance at a shortfall of 0.4 percent of GDP next year, the International Monetary Fund said in a report on the world economy published July 16. That compares with a forecast deficit of 6.8 percent in the U.S., the world’s biggest economy. The difference means Germany will probably cut its debt to 80.1 percent of GDP next year from 82.2 percent while U.S. debt is expected to jump to 110.7 percent of GDP from 106.7 percent of GDP in 2012, the IMF said.
“When you look at other matters of fiscal responsibility it’s easy to argue that Germany is and has just been flat out running their country better than the U.S., to the point where that makes a difference in demand,” said Andrew Brenner, head of international fixed income at National Alliance Securities capital markets group in New York.
The risk-adjusted return isn’t annualized. It’s calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
Germany debt ranked top because it had below average volatility when compared with other members of the G-7, which also includes Japan and Italy. Volatility averaged 4.89 for bunds over the past five years, versus 5.24 for the group of developed nations, data compiled by Bloomberg show. In the U.S. debt market, volatility was 5.52.
Treasuries, which produced a total return of 40.7 percent since June 2007 as measured by Bank of America Merrill Lynch’s Master Treasury Index, have only outperformed Japanese and Italian debt on a risk-adjusted basis. Bunds are up 41.3 percent during the period, according to the Bank of America Merrill Lynch index data.
To some extent, the outperformance of bunds over the past five years reflects a shrinking supply of safe assets that are denominated in euros, as the sovereign debt crisis that started in Greece, Portugal and Ireland spread to Spain and Italy. Investors fleeing those countries for safer assets helped drive German bund yields to record lows, with two-year yields dropping to negative 0.097 percent on Aug. 2 and benchmark 10-year yields falling to an all-time low of 1.127 percent on June 1.
“With sovereign balance sheet deteriorating there aren’t many places to go, so investors choose Germany,” said David Hoffman, co-portfolio manager who oversees $28.5 billion in debt at Brandywine Global Investment Management in Philadelphia, said in telephone interview Sept. 10. “At some point, Germany ends up holding the bag for the saving of Europe, but for now they’ve been the most popular safe haven.”
Investors are emboldened by a German budget deficit that’s projected to be 0.8 percent of gross domestic product this year, compared with a 3.2 percent shortfall for the euro region, according to IMF data. Germany’s current account surplus, a broad measure of trade, is predicted to be 5.2 percent of GDP, compared with the euro-region average of 0.7 percent.
Germany’s fiscal policies have bolstered returns on bunds even as austerity measures pushed by Merkel threaten to plunge the region further in into recession. The 17-nation region is forecast to shrink 0.5 percent this year, while the U.S. economy probably will expand 2.2 percent, Bloomberg surveys show.
Bunds beat Treasuries also over three years, the riskless return ranking shows, though they lost the top spot to Canadian bonds. Since the start of this year, French and Italian government bonds did best as European leaders took steps to contain the debt crisis.
Yields on 10-year bonds have risen from close to record lows after ECB President Mario Draghi endorsed buying debt. Policy makers agreed Sept. 6 on an unlimited bond-purchase program aimed at regaining control of interest rates in the euro area and fighting speculation of a breakup of the single currency. The purchases will be fully sterilized, meaning that the overall impact on the money supply will be neutral.
Bundesbank President Jens Weidmann criticized the ECB’s bond-buying plan the same day, saying it is “tantamount to financing governments by printing banknotes.” The Bundesbank, which is required to carry out ECB policy decisions, didn’t say it would stand in the way of bond purchases.
“Things are still far from being clear in Europe though, especially because the fiscal side is so muddled,” said Carl Lantz, head of interest-rate strategy in New York at Credit Suisse Group AG, one of 21 primary dealers that trade with the Fed. “And until they are clear, bund yields will stay low.”
The relative strength of the U.S. economy, by contrast, has hurt Treasuries relative to Germany debt even as Fed Chairman Ben S. Bernanke and the central bank purchased $2.3 trillion of debt from 2008 to 2011. Fed policy makers meeting today and tomorrow are set to consider further easing to shore up the world’s largest economy. Unlike the ECB, the Fed wants to add more cash to the economy.
“There is also a sense that the U.S., having addressed its problem early, is more likely to embark on a tightening cycle sooner than the euro region where growth will stay low for a long time,” said Jack Kelly, who helps oversee $250 billion at Standard Life Investments in Edinburgh.
The U.S. budget deficit will reach $1.1 trillion this year, according to the nonpartisan Congressional Budget Office. That would be down from last year’s $1.3 trillion, in part because tax revenue has risen by almost 6 percent and spending is down by about 1 percent this year.
The fiscal strains may be exacerbated as the U.S. risks lapsing into recession next year if lawmakers and President Barack Obama can’t break an impasse over the federal budget, and if the George W. Bush-era tax cuts expire, according to a report by the CBO published on Aug. 22 on what’s become known as the fiscal cliff.
Moody’s Investors Service said yesterday it may lower the U.S.’s credit rating to Aa1 from Aaa if an agreement on the debt ratio isn’t reached. S&P stripped the U.S. of its AAA credit rating for the first time in August 2011.
Even with the downgrade, Treasury yields fell to record lows as investors sought the most liquid of assets while seeking to preserve capital as U.S. growth slowed and Europe’s debt crisis worsened.
A Bank of America Merrill Lynch index shows the number of issues in its AAA index fell to 3,599 from 5,331 in 2007.
The global supply of the highest-quality securities, as measured by ratings companies, is poised to fall by as much as $4 trillion, according to the IMF. Reforms such as the Dodd- Frank financial-overhaul law and global regulations set by the Bank for International Settlements require institutions to hold more top-graded debt.
Lenders have an added incentive to buy both bunds and Treasuries after the Basel Committee on Banking Supervision proposed rules in 2011 that banks increase available capital to bolster the cushion against potential losses and better measure and control their risk.
“At the end of the day, both nations represent the safest and deepest bond markets around the globe,” said Gary Pollack, who helps manage $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “There is a lot of uncertainty ahead for both countries, but market confidence in the U.S. and Germany’s economy and policy makers still remains high, for now.”
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