Germany loses its safe haven status
German government bond yields used to fall in crisis times - but now they're rising
Over the weekend I wrote a post about the global rise in long-term government bond yields. That post identified three factors driving yields higher: (i) the global debt binge during COVID made markets less willing to provide cheap financing to governments, especially with many countries still running wide deficits long after the pandemic has passed; (ii) idiosyncratic trouble spots like France and Japan are making markets more attuned to fiscal risk, which is putting upward pressure on yields elsewhere; and (iii) the universe of safe havens is shrinking, with Germany losing that status this year.
In today’s post, I take a look at what’s going on with Germany. There’s two things happening. The first is domestic and comes from the softening up of Germany’s debt brake and large fiscal stimulus that were announced in March. In effect, Germany is assimilating to the rest of the Euro zone, where more debt is the universal answer to whatever shock comes along. The second is external and stems from Germany’s status as weak hegemon in the Euro zone. Again and again, Germany has proven itself unwilling to confront high-debt countries like Italy and Spain and push for fiscal consolidation. Instead, Germany has turned a blind eye to an increasingly activist ECB that caps yields of high-debt sovereigns when those go too high. Markets have reasonably concluded that - if Germany failed to confront Italy in good times - it certainly won’t do so now with war in Ukraine. In effect, markets are increasingly trading a synthetic Euro bond, which means German yields gets pushed up, even as yields for high-debt countries rise less or even fall.
The two charts above illustrate what’s going on. The left chart shows the 10-year government bond yield for Germany (blue line) and the 10y20y forward yield (red line) that I’ve backed out from 20- and 30-year bond yields. This 10y20y forward yield is what markets price for the 10-year yield in 20 years’ time. The right chart shows the same for Switzerland. The difference between the two is striking. A true safe haven like Switzerland is seeing yields fall sharply across the yield curve, even at the very long end. That’s no longer true for Germany, where the 10y20y forward yield is up very sharply this year, at a time of elevated global uncertainty that - in the past - would have seen German yields fall.
The erosion of Germany’s safe haven status is unambiguously a bad thing for German tax payers. It’d be one thing if fiscal stimulus made Germany safer from Russia. But that’s unlikely. As I’ve pointed out on many previous occasions, only shutting down Putin’s shadow fleet of oil tankers in the Baltic can do that, which - incidentally - doesn’t cost a penny. I worry this stimulus is about appearances, to give the illusion that important things are being done when really they are not. The increasing mish-mash of Euro zone government debt that’s happening via the ECB is a whole separate can of worms. In effect, governments are being backstopped with zero conditionality and zero pressure to reform. That will only make Euro zone debt overhangs worse over time. The Euro zone just isn’t on a good trajectory.
The loss of safe haven status for Germany has a negative externality for the world. It means there’s one less place to hide when global uncertainty rises, which may explain why gold has seen such a massive rally this year. After all, there’s only so much hiding you can do in tiny Switzerland.
Great post. I’ve been following the OAT-Bund and then Gilt-Bund yields. A few things stood out which *you* had semi-constructed:
1. I was at the desk when OAT-Bund first came up and naturally tried to generalize to other cases like Gilt rates; it’s amazing it took so long for the other differentials to gear up
2. You are absolutely correct about the ECB both cushioning the blow and helping it spread as individual countries aren’t penalized as harshly; curious incentive structure
3. You made the very good argument that American tariffs on Chinese goods export deflation to the rest of the world due to the glut. German industry being eaten at by Chinese imports is hitting the trust in the German economic engine and exacerbating the bond crises.
Your view of Germany‘s loss of reserve status or high-quality status is just unsupported by the facts. Look at their shorter rates not the very liquid longer rates you’re part of the global system that’s now just calling for higher yields for longer or transformation. It’s bizarre how you could lose your rational thought. All notes in America are so well. They cause a policy reduction response. How long before our low rates bring their low rates down and they do a policy response. You’ve lost it.