MacroScope

Breaking up is hard to do – even for stoic Germany

June 15, 2012

German Bund futures have just had their second straight week of losses. This has left many scratching their heads given the timing – right before Greek elections that could decide the country’s future in the euro and the next phase of the euro zone debt crisis. That sort of uncertainty would normally bolster bunds, which are seen as a safe-haven because of the country’s economic strength.

To explain the move, analysts pointed to profit-taking on recent hefty gains, and to a bout of long-dated supply from highly-rated Austria, the Netherlands and the European Financial Stability Fund this week. They also noted changes in Danish pension fund rules as an additional technical factor reducing demand for longer-dated German debt.

The losses, however, have also prompted some debate about whether contagion is spreading to Germany, the euro zone’s largest economy.

The thinking is that Germany will likely pay a high price for whatever the outcome of the euro zone debt crisis – be it further sovereign bailouts or issuance of common euro zone bonds. Euro bonds could drive German yields higher, but many market analysts still see them as the best and perhaps only way of drawing a line under the crisis.

A break-up of the single currency meanwhile would be extremely messy and costly – especially for Germany.

According to one trader in London:

(German Chancellor Angela Merkel’s) tone has changed a little bit, and I think that that’s Germany admitting that ‘hey we benefited from the euro too. We are one of the world’s most effective producer of economic goods and for five years now we have been maintaining a currency that is artificially weak versus what our economic fundamentals suggest.’

Realistically their currency should be appreciating much like the dollar has in these crisis periods. But instead during these crisis periods they are pegged to a currency that continues to depreciate. You are looking at a pretty significant boost to Germany’s economy.

Those are the arguments behind the fundamentals of what’s driving the Bund market and it’s really hard to say where their value is.

The market decided to run the numbers very recently and they came to this conclusion that Germany stands to really take it on the chin, I think that’s what we are looking at. If the euro zone breaks up, Germany stands to be a loser of that.

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