The prospect of an economic rebound midwifed by Mario Draghi’s successful calming of the European bond market may finally prompt Germany to sell 30-year inflation-linked government debt.
Draghi’s European Central Bank forecasts the euro region will rally from recession in 2013, while European Union leaders say the worst of the debt crisis is over. The prospect of those forces stoking inflation is sharpening investor appetite for a top-rated, long-dated security after France’s rating downgrade left the region without a AAA index-linked security with more than 10 years to maturity.
“We are likely to be a buyer of German 30-year index- linked debt if they offer,” said Robin Marshall, a fixed-income director at Smith & Williamson Investment Management in London, which oversees the equivalent of $19 billion. “Inflation may not be a threat in the euro zone now, but I would like to be able to express a longer-term view on that without having to take a credit risk. At the moment, it’s not easy to do that.”
Germany came late to the inflation market, selling its first bonds linked to consumer prices in March 2006. The U.K. issued inflation-protected securities in 1981, with France tapping the market in 1998 and Italy debuting in 2004. The debt is designed to keep its value when consumer prices rise.
Gerhard Schleif, the former head of Germany’s Federal Finance Agency, said in 2007 that 30-year linkers might appear that year. Carl Heinz Daube, who took over in 2008, reiterated the government’s intention to sell the securities. Daube stepped down today. He is being replaced by Tammo Diemer, with investors still awaiting the first sale.
“We will continue to monitor the market situation,” Joerg Mueller, a spokesman for the debt agency, wrote in an e-mailed response to questions last week. “Our entry into this market segment in 2006 was linked to the longer-term expectation of a reduction in interest-rate costs. It was also aimed at broadening the investor base, increasing financial flexibility and extending the spectrum of securities offered to investors.”
Long-term inflation expectations have risen in G-10 countries on speculation the global economy will grow at faster pace than last year. Global output will expand 2.4 percent this year and 3.17 percent in 2014, according to a median forecast of economists surveyed by Bloomberg.
France’s 15-year breakeven rate, a gauge of the consumer- price outlook derived from the yield gap between regular and index-linked bonds, is at 2.24 percentage points today, compared with 1.99 percentage points a year earlier. The 30-year U.S. rate increased to 2.55 percentage points from 2.16 during the same period, while the U.K. 30-year gap widened to 3.26 percentage points today from 3.20.
“To be fair to Germany, a number of things had happened soon after it first sold index-linked bonds that made it rather difficult to issue 30-year linkers,” said Markus Heider, the head of inflation research at Deutsche Bank AG in London. “We had the financial crisis followed by the euro debt crisis. People were more worried about recession than inflation. You can make an argument that the market conditions and valuations have improved. It’s a better time to issue such bonds.”
Germany’s longest-maturity inflation debt is repayable in April 2023. While the country has one of the world’s most traded bond markets, it has 55 billion euros ($73.5 billion) of index- linked securities, compared with 173 billion euros in France and 290 billion pounds ($465 billion) in the U.K.
Italy had its inflation securities removed from Barclays Plc’s indexes in July after Moody’s Investors Service cut its credit rating, making investors using those indexes to track performance less likely to buy its bonds.
“If Germany wants to be a benchmark issuer in the index- linked bond market, it will need to issue 30-year securities,” said Kari Hallgrimsson, the head of European inflation trading at JPMorgan Chase & Co in London. “We have heard of strong interest for long-dated German linkers from pension funds in Scandinavia, the Netherlands and Germany. The market will take it very positively.”
German Finance Minister Wolfgang Schaeuble said Jan. 11 that the euro region is over the worst of the crisis. Draghi cited “positive contagion” in European markets after the central bank left its benchmark rate at 0.75 percent on Jan. 10, telling reporters that “a gradual recovery should start” in late 2013.
While data today showed growth in Germany slowed to 0.7 percent last year from 3 percent in 2011, there were positive signs for the economy. The country’s business confidence rose for a second month in December, unemployment held close to a two-decade low, and industrial production and retail sales increased in November. Financial markets also recovered at the end of last year, with the benchmark DAX index gaining 11.5 percent since mid-November.
The yield on 15-year French index-linked bonds has fallen to about 0.50 percent from 1.39 percent at the end of June, underlining demand for long-dated inflation securities. German securities due in April 2023 yielded minus 0.20 percent, compared with 0.01 percent in mid-2012.
The German debt agency may have to prove to the government that adding a new line of debt is cheaper than selling regular securities, said Paul Mueller, a money manager at Invesco Asset Management in London. It also may be concerned about potential changes in the pension fund industry reducing demand.
“Pension regulations may present a risk, but at the end of the day, the size of the euro-region’s index-linked market is relatively small,” Mueller said. “Investors still need long- dated inflation protection and they don’t have many sources to go to in the euro region. German 30-year inflation bonds will have a great appeal to investors.”
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