• Home
  • About
  • Subscribe
  • Conference
  • Events Calendar
  • Webcast151
  • MOTB
  • Log In
  • Register

Room 151

  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews

The case against bunds

0
  • by James Bevan
  • in Blogs · James Bevan · Treasury
  • — 15 Nov, 2011

It is perhaps ironic that, as a result of the massive expansion of lending to the Euro System’s TARGET mechanism and its involvement in the ECB’s support operations for peripheral bond markets, the once
conservative German Bundesbank now finds fully 65% or perhaps more of its assets consisting of claims on peripheral banks or governments. Moreover, over the last three months, the Bundesbank has experienced an annualised rate of growth of some 120% in its balance sheet and we can only assume that in time the rate of reserve money growth within its domestic banking system will reach similar proportions. These are remarkably ‘un-German’ events and the German state now has close to three quarters of a trillion euros now riding on the euro Project.

Only five years ago, 25% of the Bundesbank’s assets were accounted for by gold and FOREX and 60% were claims on German domestic banks, and at an extremely broad level, the implicit compromising of the
Bundesbank’s balance sheet through its actions to support the Euro must reduce its credibility and reputation as a hard money authority, and this could reasonably lead to a de-rating of Bunds over the long term.

Moreover, by apparently providing an offsetting officially-sponsored capital inflow for the periphery, the Bundesbank is implicitly lessening the deflationary pressure on these balance of payments deficit countries. However, if these countries do not deflate as is notionally intended by the ECB, then the re-establishment of a long-term competitive equilibrium position within Euroland will require Germany to experience a notably higher trend rate of inflation, which we would also argue as being a negative factor for Bunds. We would suggest that in order to re-establish competitiveness in the periphery, German inflation would have to be 200-300bps above that of the periphery for a significant period of time, which suggests the potential for an average rate of inflation in Germany over the next five to ten years of perhaps four percent. Such a rate would be two and a half times the average rate experienced 1995 – 2010 and clearly this would represent a problem for Bund prices.

If the euro were to break apart, however, then we suspect that the supply of Bunds might leap. The authorities might easily face a bill of €150bn to recapitalise both the Bundesbank and the commercial banks, while the real economy might also need some fiscal assistance as the new currency soared. This supply pressure that this would create in the Bund market could easily match that created by the 2009-2010 fiscal easing.

Finally, we would note that the euro crisis has been an extraordinarily positive factor for Bunds.

According to the German BoP data, foreign purchases of Bunds have been running at a €80bn rate, roughly twice that which existed prior to the Crisis. Moreover, it is also clear that perhaps as much as a third of the foreign ‘flight capital’ from the periphery that flowed into German domestic banks may have subsequently been placed by the banks within the Bund Markets. On a simple ‘back of the envelope basis’, the uncertainty over the fate of the Euro seems to have resulted in €200bn increase in direct and
indirect Bund holdings by foreigners. On top of this amount, they may also have been an increased demand for Bunds for use as collateral given the decline in the number of ‘alternatives’ now available to financial sector borrowers in the collateralised credit markets.

Once the euro crisis is resolved one way or another, presumably either the ‘new DEM’ will have soared, thereby removing much of the rationale to hold Bunds’, or the risk of holding money in the periphery will
have declined following a solution to the crisis and money will begin flowing back to these higher yielding areas. Either way, we may wonder if once the crisis is resolved, several hundred billion of flight capital may ultimately seek to leave the Bund market at a time in which either the German budget deficit is expanding (after a EUR breakdown) or German inflation is rising following a successful euro rescue. It therefore seems to us that in the run up to the euro breaking or being rescued, Bunds may continue to perform well but once clarity returns to the situation, Bund prices should fall, if not in absolute terms (which we think is probable) then at least relative to the periphery on a currency hedged basis.

So much for government bonds being low risk.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla

Share

You may also like...

  • James Bevan: The Fed and ECB’s divergent paths James Bevan: The Fed and ECB’s divergent paths 10 Dec, 2015
  • CFO secrets: Revisiting ‘purpose’ helps ensure your finance function is fit for the job 11 Sep, 2020
  • David Green: Taking a ‘balanced view’ of borrowing 12 Oct, 2020
  • Making sense of climate risk reporting for LGPS 2 Mar, 2021

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • Register to become a Room151 user

  • Latest tweets

    Room151 12 hours ago

    Going beyond the standard metrics for climate change: Sponsored article: With climate change an investment imperative and an imminent reporting requirement, Ritesh Bamania argues UK pension schemes should look beyond today’s standard metrics. With… dlvr.it/RtnpLS pic.twitter.com/6ABaFHyS9I

    Room151 1 day ago

    LGPS webinar: Governance the key to TCFD implementation: LGPS funds have been warned that governance is it at the here of Whitehall plans to impose a new climate reporting regime on pension funds. In January the Department for[...] dlvr.it/RtjwNq pic.twitter.com/YMiMdmRyzU

    Room151 1 day ago

    LGPS webinar: Central bank management of bond purchasing could affect all asset classes: When the government debt caused by the pandemic is eventually tackled there may be a huge impact on assets of all classes, according to a leading investment expert… dlvr.it/RtjwJx pic.twitter.com/7v8K5vMYHo

    Room151 2 days ago

    #LGPS readers...what to do about #bonds? room151.co.uk/blogs/lgps-web… @BrunelPP 's new CIO, David Vickers tackles a problematic area #centralbanks #assetallocation #fixedincome pic.twitter.com/yUJr0azbKv

    Room151 2 days ago

    LGPS Challenges: Balancing Realpolitik and responsible investment: Elizabeth M. Carey warns of the perils of an ESG echo chamber as countries outside the West continue to invest in fossil fuels. Anyone working with the LGPS probably feels[...] dlvr.it/RtjMpq pic.twitter.com/MykIYxuYri

    Room151 5 days ago

    How can local government ‘build back better’?: Beverley Gower-Jones looks at the options for driving small business entrepreneurship in clean technologies. Innovation is essential for local authorities to save money and reduce emissions, it is the… dlvr.it/RtT3nS pic.twitter.com/bSMB6OG70t

    Room151 5 days ago

    Helen Randall: Spelthorne report places spotlight on ‘controls’: Fresh criticism of Spelthorne Council raises the question of what “good” controls look like when negotiating a property deal. Spelthorne Council’s continuing debacle over property… dlvr.it/RtSPhy pic.twitter.com/9uCOJgBcH6

    Room151 5 days ago

    Step-out strategies: Hitting the sweet spot between liquidity and ultra-short duration: Sponsored article: Jemma Clee describes how an ultra-short duration strategy can help local authorities enhance returns. Despite the expectation of a low, and… dlvr.it/RtSPZb pic.twitter.com/pdXPpv5lcN

    Room151 6 days ago

    What role will climate change have on the pricing of government bonds?: Sponsored article: Kerry Duffain finds that “vulnerability and resilience to climate change” have a significant impact on the cost of government borrowing. Ardea Investment… dlvr.it/RtNKv7 pic.twitter.com/wDjT31x4Yt

    Room151 1 week ago

    ESGenius: Slashing emissions will fuel green growth for decades: Sponsored article: Velislava Dimitrova argues that a big enough investment could mean transition to a low, or no, carbon economy can become a reality. The world needs to slash carbon[...] dlvr.it/RtKZJp pic.twitter.com/cd8S3ijERl

    Room151 1 week ago

    Prudential code: “Not perfect, but its heart is in the right place”: The new Prudential Code offers revised rules for borrowing. Nikki Bishop is sceptical it will work while Gary Fielding offers his support. Nikki Bishop I have been asked to give[...] dlvr.it/RtKZFh pic.twitter.com/OriN28lXcb

  • Categories

    • 151 News
    • Agent 151
    • Blogs
    • Chris Buss
    • Cllr John Clancy
    • Dan Bates
    • David Crum
    • David Green
    • Development
    • Forum
    • Funding
    • Graham Liddell
    • Ian O'Donnell
    • Interviews
    • Jackie Shute
    • James Bevan
    • Jobs
    • LGPSi
    • Mark Finnegan
    • Recent Posts
    • Resources
    • Richard Harbord
    • Stephen Fitzgerald
    • Stephen Sheen
    • Steve Bishop
    • Technical
    • Treasury
    • Uncategorized
  • Archives

    • 2021
    • 2020
    • 2019
    • 2018
    • 2017
    • 2016
    • 2015
    • 2014
    • 2013
    • 2012
    • 2011
  • Previous story Merkel’s divisive reunification speech
  • Next story AAA for Wandsworth from Moody’s & Fitch

© Copyright 2021 Room 151. Typegrid Theme by WPBandit.