Frexit Fears

Happiness Is a New Schatz

Wednesday's bund auction could tell a different story.

Happiness is issuing a new two-year bond with a princely zero percent coupon and seeing investors queue up to pay nearly 102 percent for it (despite them knowingly receiving only 100 percent back). The specter of Frexit and redenomination risk loom large in Europe, and the ardor for German credit, the finest available in the euro-area, looks undimmed. But Wednesday's 10-year bund auction is another matter.

The yield at Tuesday's Schatz sale was minus 0.92 percent, very close to the all-time low and substantially down from minus 0.75 percent at the last sale. Simply put if the worst were to happen and the euro became no more, investors would rather be left holding German risk -- and they are prepared to pay for it.  

Burrowing Ever Deeper

2-year German debt has been below the ECB's -0.40% deposit rate for over a year

Source: Bloomberg

But there's a bit more to it than that. The short end's the star these days. Analysts at Citigroup Inc. reckon the European Central Bank's quantitative easing will remove about 80 billion euros ($84.8 billion) of German debt due from one to six years from the market this year. That means that effectively there will be negative net supply in these shorter maturities, just as investors are seeking extra security ahead of Dutch and French elections.

The collateral squeeze, which Gadfly has warned about here and here, is set to worsen with the new European market regulations coming into force Wednesday. 1  This is a regulatory attempt to push investors towards centralized clearing, and means many them who've never had to post collateral now will may have to do so to trade derivatives. This will maintain super-high demand for top securities -- such as the Schatz.

However, there's plenty of reason to think Germany's planned 3 billion euro increase of its existing benchmark 10-year bund could get sloppy. The yield dropped about 30 basis points in February to a paltry 20 basis points, so its a stretch to see anyone being happy with that. Centrist French Presidential candidate Emmanuel Macron's stronger poll showings have calmed investors' nerves on his country's debt, which should ease the scramble for the safest of securities.

Fabulous February

Flight to quality helped Bunds steadily strengthen

Source: Bloomberg

The sheen on German debt certainly came off a bit with the failure of last week's 30-year auction -- 733 million euros of bids for a 1 billion euro issue is rather a poor showing. It seems not even Europe's biggest economy could avoid the market's distaste for the long end these days.

Yet this bund tap will probably muddle through just fine. 

Total net German supply this year will be not much more than about 1.5 billion euros a month. Add in the European Central Bank's continued QE, and it is not difficult to see why bund yields are so low -- even if the central bank will ease off its pace of buying in April from 80 billion euros a month to 60 billion euros.

This is a case of regulatory interference dimming the signal we should be seeing from shifting sentiment. At these levels, quite what the purpose is of continuing QE is a mystery. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. For a market request to get the deadline extended, see Feb. 7 2017 letter here. To see European officials refusing to extend the deadline, see here.

To contact the author of this story:
Marcus Ashworth in London at

To contact the editor responsible for this story:
Jennifer Ryan at

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