Martin Steward: Why can't Germany sell its bonds?
In its worst auction of the euro era, Germany tried to sell €6bn worth of Bunds on the morning of Wednesday 23 November - and could only hit a bid for €3.6bn.
For those who had gotten used to thinking of these securities as the safe haven at the heart of the euro-zone crisis, this came as a shock. For those who balked at the average bid yield of 1.98%, it probably did not. They may have been vindicated in walking away from the auction, as yields jumped more than 30 basis points over the proceeding 24 hours.
So what went wrong?
There are perhaps three explanations: optimistic; a mix of relatively optimistic and gloomy; and apocalyptic. The fact I begin with the optimistic explanation may indicate where my view falls on this spectrum.
Equity markets like the 'optimistic' scenario: they have snapped a very long losing streak today - in the UK, the FTSE 100's eight-day streak ranks among the very worst. The DAX has rebounded particularly strongly, up 1.3% around midday. At any other time, that would make perfect sense: Germany posted pretty good Q3 GDP growth numbers, in line with economists' expectations, and excellent export numbers, which exceeded those expectations. The result? European equities up, German Bund yields up - QED.
The "relatively optimistic" interpretation was offered to me this morning by Luc Sitbon, an ex-Bank of America fixed income specialist, who, alongside his wife Delphine, now runs a successful London-based hedge fund start-up called LD Capital.
"I have a strong opinion about what happened yesterday," he said. "International investors - British, American and Asian buyers - have had enough of Germany's position on the euro issue, and to signal that, they simply decided to boycott the auction. It was a way of saying: 'We've asked you nicely, but if you don't change your approach, we can show you that we can stop buying your bonds as well'."
Actually, that's a mix of the 'optimistic' and the 'gloomy', depending on your view of what happens when Germany and the ECB open up their balance sheets to save the single currency. Rising Bund yields could either signal the start of a market revolt in the face of runaway inflation and euro debasement (you'd want a lot more than 1.98% if you thought the value of your cash flows was about to embark on a downward spiral); or reflect the positive impact that a weaker euro would have on German exports - just as the equity markets appear to believe today.
But equity markets have missed the signals from bond markets already this year, when they ignored the collapse in safe-haven yields through May and June that should have warned them about what awaited investors in Q3. They would do well not to ignore the very different signals being sent out over the past few days and weeks.
This is where it gets apocalyptic. If we think striking Bund buyers can successfully force Germany to back the euro, and Bund yields are rising because the market is starting to price-in both that contingent liability and the resulting weakness of the currency, we would surely see peripheral euro-zone yields falling in response. After all, it would make the prospect of full-scale default by the likes of Italy and Spain that much smaller.
But we haven't seen that. As recently as June into July, we saw a combination of the correlation of the daily moves in German and Italian 10-year yields collapsing while the spread of Italian bonds over Bunds hit the stratosphere - clear symptoms of the 'Bunds-as-a-safe-haven' trade.
Since then, we have had periods of uncertainty around that trade. For most of October, the correlation went up while the spread remained stable. One can argue that was consistent with a thesis that was bullish on the German economy but concerned about the euro-zone periphery. But, since around 8 November, that spread has come in by 60-70bps - and most of the move has come from the Bunds, not the Italian paper. The past four days has seen a consolidation of that trend: investors are selling-off both the periphery and Germany; the spread of Bunds over US Treasuries is at its highest since spring 2009.
We all wanted to see euro-zone yield convergence - but not this kind of convergence. Are the markets starting to look into the abyss of euro-zone break-up and banking crisis, and price it in? Or are they just dangling Germany over that abyss to give them a taste of what it would be like to fall in? Let's hope for all we are worth that it's the latter.