Will Germany soon be paid to issue ten-year debt?


Ten-year German bonds hit their lowest yields since April 2015 last week, closing at 0.02%. Germany could soon join Switzerland and Japan, the only two countries with negative ten-year yields. Currently, 80% of German government debt trades at negative yields to maturity. The sharp rise in risk aversion, fuelled by recent poor US job creation figures and Brexit polls suggesting an increased likelihood of the UK leaving the EU, may have pushed yields down.

The question is, can conclusions still be drawn from an asset price in such a distorted market? With no deficit, Germany issues very little debt beyond renewing its existing stocks. Meanwhile, the ECB purchases approximately 19 billion euros of German bonds every month, enough to absorb a public deficit of about 7.5%. In a context where many investors are resorting to government bonds, the ECB’s intervention is making the information provided by Eurozone risk-free assets less reliable.

Our analysis

When considering nominal rates, inflation has to be factored in. Inflation swaps currently reflect market estimations for inflation of about 1.0% on average over the next ten years, i.e. Bund buyers are currently accepting an annual real interest rate of about -1.0%.  Yet at today’s rate levels, Bund duration stands at about 9 years, i.e. if ten-year rates were to return to the 1% level the resulting price fall would be about 9%. In a context where Eurozone growth is gradually improving, inflation should pick up, especially as oil prices, if they remain at current levels, should pull it upwards in the coming months.

The opinion expressed above is dated June 10th, 2016 and is liable to change.

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