German Bonds Lose Favor as Bailouts Loom

Help for Spain, Italy will take toll on Germany’s finances

Investors are wary of the German chancellor, Angela Merkel, who appears to be giving ground to European Central Bank (ECB) President Mario Draghi and his plan to purchase Spanish and Italian bonds to help quell the financial crisis in the eurozone. As a result, they are pulling money out of Bunds and seeking what they see as safer investments.

Chancellor Angela Merkel of Germany (Photo: AP)Bloomberg reported Monday that Merkel (left), who had been strongly opposed to the ECB buying bonds, has been pushed not only abroad but at home by the Social Democratic Party (SDP), the main opposition party to her own. The Social Democrats have called for Germany to shoulder more of the expense in a rescue to prevent the breakup of the euro.

Even a potential challenger to Merkel has voiced support for closer fiscal integration in the form of joint eurozone bonds. Peer Steinbrueck, a former German finance minister who may oppose Merkel in the 2013 election, said Saturday that he supported SPD Chairman Sigmar Gabriel's recent call for issuance of common eurozone debt and greater fiscal integration.

Steinbrueck dismissed Merkel’s own party’s characterization of common debt issuance as “debt socialism.” He said in the report, "They're being featherbrained," and went on to say that the eurozone crisis has already eliminated all but two options for the European Union (EU): surrender of more sovereignty to Europe or regression toward “renationalization.” The latter, he said, "would be a fatal way to go" for export-based Germany.

The pressure has taken its toll; on Aug. 6, Merkel's deputy spokesman Georg Streiter said she now supports Draghi’s bond buying plan in order to help lower borrowing costs in Spain and Italy. As a result, German Bunds, which have had yields below zero as investors sought them out as a safe haven from the fiscal troubles of the bloc, are now being sold off.

“The risk that Germany will have to issue more debt to finance the bailout is real,” Johannes Jooste said in the report. Jooste, a senior strategist in London at Merrill Lynch Wealth Management, which oversees $1.8 trillion globally and has cut bund holdings since last year, added, “I’m skeptical of investing in zero-yielding paper. I’m not convinced the current yields are justified.”

He is not alone. Rose Ouahba, head of fixed income at Paris-based Carmignac Gestion, which manages about $60 billion, said in the report, “I don’t have a lot of confidence about what is going to happen in Germany.” She divested of Bunds in June and is now relying on Treasuries.

Other firms have headed for the exits as well. Fidelity Investments and PIMCO, as well as Ignis Asset Management in Glasgow, Scotland, and banks such as BNP Paribas, Royal Bank of Scotland Group and Barclays have all sold Bunds or are paring their holdings of them.

All are concerned over the potential cost to Germany if Spain and Italy have to be bailed out. In such an eventuality, research firm Graham Fisher & Co. estimates that the cost to Germany of could run as high as 500 billion euros ($614 billion).

PIMCO is of the opinion that Bunds are overvalued; in fact, a bubble could be taking shape. Myles Bradshaw, executive vice president and money manager at PIMCO in London, was quoted saying, “If you are confined to Europe, then you would prefer to get into more attractive alternatives than Bunds. Globally there are much better alternatives to Bunds. The euro is facing an existential crisis and Bund valuations are expensive.”

Josh Rosner, a banking analyst at New York-based Graham Fisher, said in the report that Germany must either accept the costs of greater fiscal integration among the nations of the eurozone or face the loss of its position as a safe haven.

Among the steps that should be taken to achieve that integration, Rosner said, were empowerment of the ECB to rescue banks, creation of a deposit insurance program and permission for the ECB to print money the way the Federal Reserve does so that it can push growth.

“As the ultimate costs to Germany become understood, we will see a flight to havens outside of the eurozone,” he was quoted saying. “The best-case scenario is that Germany’s government finally tells its people, ‘Look, there are the costs associated with each of these solutions.’ It’s either full integration or full dissolution.”

“Germany is facing a no-win situation,” according to Brett Wander, chief investment officer for fixed income in San Francisco at Charles Schwab Investment Management Inc. Wander said in the report, “They could either step up and do a disproportionate amount of work and pay a disproportionate price to keep the system afloat, or if they choose not to, then they will suffer in the long run. It’s not fair, but they have no other choice. They all sink or swim together.”

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