Why Germany’s bond market is increasingly hard to trade - Financial Times

After a record-breaking rally in bond markets, all of Germany’s government debt now trades at sub-zero yields. That raises an important question: what kind of investors are happy to hoover up bonds that guarantee a loss if they are held to maturity?

One answer is that investors — in the sense of fund managers seeking to generate a return on their clients’ money — do not actually own very much of the German bond market.

An analysis by Union Investment, a Frankfurt-based asset manager, shows that the overall value of Bunds outstanding has been falling slightly since 2014 thanks to Germany’s aversion to running budget deficits. But the volume of freely tradable Bunds on the market has fallen much more sharply, and is expected to drop below €70bn by 2024 down from more than €600bn a decade earlier.

The precipitous drop has been caused by the rise of a class of bondholders typically indifferent to the level of yields. These include foreign reserve managers at central banks, financial institutions that since the crisis have had to hold ever larger piles of government bonds to meet regulatory requirements, and the German central bank itself. The Bundesbank holds more than €350bn of Bunds as a result of the European Central Bank’s quantitative easing programme.

Chart showing billions of Euros showing that, as Germand debt levels have reduced, demand for German bunds has soared

Jörg Zeuner, chief economist at Union Investment, argues that the lack of tradable Bunds is distorting the market, which serves as a benchmark for assets across the eurozone. “If the German government continues to pursue a balanced budget, the supply shortage will worsen,” he said. “The implications for the capital market would be substantial. This is detrimental to pricing and can make prices less meaningful.”

A revival of the ECB’s QE programme — which is widely expected by investors — would exacerbate the scarcity of Bunds, given the central bank would probably have to rewrite its own limits on how much of the market it can own.

Given the paucity of Bunds, it is not surprising that Berlin is under growing pressure to borrow more, particularly with the German economy seemingly headed for recession. But the modest scale of fiscal loosening plans — finance minister Olaf Scholz has discussed a €50bn stimulus package — seems unlikely to alter the dynamics of the Bund market, for now.

Mr Zeuner said: “These amounts would still imply a falling debt-to-GDP ratio.”