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Merkel Winning Euro-Bond Clash as German Bunds Gain: Euro Credit

July 10, 2012

German Chancellor Angela Merkel

Angela Merkel, Germany's chancellor. Photographer: Alessia Pierdomenico/Bloomberg

Investors are declaring German Chancellor Angela Merkel the winner in her battle against euro- region bonds as a way of easing the debt crisis.

Since Merkel conceded to demands of relief for Spain and Italy at a European Union summit on June 29 while opposing the sale of the bonds, the debt of the euro area’s remaining AAA nations have outperformed U.S. Treasuries. Yields on 10-year debt from Germany, Finland and the Netherlands, whose credit- worthiness may be diluted by common borrowing with the likes of Spain, fell by an average 34 basis points since the EU meeting.

“When you look at bund yields, the current levels are a strong signal that the market isn’t really buying into this euro bond story otherwise we would have seen a massive pullback in yields across the AAA countries,” said Michael Leister, a rates strategist at DZ Bank AG in Frankfurt. “Demand for safety and core products is still very strong.”

European leaders remain divided over how to solve the crisis, with Italian Prime Minister Mario Monti and French President Francois Hollande advocating bonds backed by all 17 members of the currency and Merkel opposing them.

As the debate rolls on, investors have pushed yields on German two-year notes below zero and Finnish borrowing costs for two years are the lowest since May 2010 relative to the U.S.

“Markets are more pricing in risk aversion than burden sharing,” said Mohit Kumar, head of European interest-rate strategy at Deutsche Bank AG in London. “The whole debt mutualisation is a long-term story and not something we are likely to get in the near term.”

Southern Yields

Ten-year bond yields for Spain were 9 basis points lower at 6.97 percent today after almost a week of gains, while those for Italy were 8 basis points lower at 6.03 percent. The German 10- year bund rate was at 1.32 percent, more than 2 percentage points below its 3.53 percent average of the past decade.

Finland’s 10-year yield has slipped to 1.53 percent from as much as 2.05 percent after last month’s summit, while rates on similar Dutch bonds dropped to 1.75 percent from as much as 2.23 percent. Luxembourg is the other country in the region with a top credit grade from the three main ratings companies.

Beating Treasuries

Europe’s so-called havens are beating U.S. Treasuries. German bonds handed investors a return of 1.54 percent, including reinvested interest, since June 29, while their Finnish counterparts returned 1.93 percent and Dutch bonds rose 1.8 percent, according to indexes compiled the European Federation of Financial Analysts Societies and Bloomberg. Treasuries made 0.71 percent in the same period.

Finland’s two-year yield was 21 basis points lower yesterday than yields on U.S. notes of similar maturity. The rate was 18 basis points higher than its U.S. counterpart as recently as April 20. Spanish and Italian bonds slumped last week as the European Central Bank cut interest rates and refrained from any additional steps to cap yields.

“The action by the ECB disappointed investors and, at least in Europe, that’s why you had the sharp selloff,” Robert Parker, senior adviser at Credit Suisse Asset Management, said in a July 6 interview with Linzie Janis on Bloomberg television’s “On the Move” program. “If we go into September, October and Spanish bond yields are still 7 percent, that is worrying and intervention will be required.”

EU leaders sparked the strongest rally in Spanish bonds this year on June 29 when they agreed to loosen bailout rules, lay the foundations for starting a euro-area bank supervisor and allow the permanent bailout fund, the European Stability Mechanism, to be used to recapitalize banks directly.

Spanish Bailout

Spain requested as much as 100 billion euros ($123 billion) of European aid on June 9 to allow it to finance banks burdened with bad loans. European finance ministers decided last night to go ahead with shoring up Spanish lenders. They may move the costs off the government’s balance sheet to shield the euro region’s fourth-largest economy from the debt crisis.

Last week’s statement by EU officials didn’t mention the euro bonds that Monti and Spanish premier Mariano Rajoy said are needed to shore up a European project that has helped maintain peace in the region. Merkel has maintained her opposition to shared debt, telling reporters in Berlin on July 5 that Germany didn’t expand its rescue commitments at the summit.

“This isn’t about taking on any additional liabilities,” she said. “Liability for banks is banned under the current rules, just like liability for states. The decisions in Brussels haven’t changed anything in that respect.”

Investors also favor the region’s safest assets because of doubts that the EU’s push to unify bank oversight, a necessary step before leaders can allow cash-strapped lenders to be recapitalized directly, will succeed amid opposition from individual national regulators.

Nordic Opposition

Danish Economy Minister Margrethe Vestager signaled July 3 that her country is reluctant to sign up to a European banking authority because such a model probably would rob national regulators of tools needed to prevent asset bubbles.

Swedish Prime Minister Fredrik Reinfeldt reiterated his country’s opposition to an EU-wide supervisor on June 27. The country’s regulator told its four biggest banks to abide by stricter rules than those set by the rest of Europe to protect taxpayers from losses.

“We all know the problems in setting up a pan-European bank supervisory authority and potential disagreements there,” said Jack Kelly, who’s responsible for about 6 billion euros of government bonds as investment director at Standard Life Investments in Edinburgh. “There isn’t going to be a massive change of heart from the Germans” on euro bonds and “bund yields will continue to move lower,” he said.

To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at

To contact the editor responsible for this story: Daniel Tilles at

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