Is last week’s sell-off in German Bunds a buying opportunity?
Last week, Germany’s decision to exempt defense spending from fiscal limits—prompted by waning U.S. support—and the proposal by incoming Chancellor Mertz to establish a €500 billion fund for medium-term infrastructure and defense investments have had a profound impact on European markets. Equities rallied, while bonds were sold off.
This shift signals a major departure from Germany’s traditionally rigid fiscal policies.
Confronted with escalating geopolitical risks and persistent economic stagnation, the new government is sending a clear message: it is willing to loosen budget constraints to stimulate economic growth.
This could mark a true inflection point—not just for Germany, but for Europe as a whole.
Not only a surge in Bund yields, but also a rise in the euro
The long-term effects on German economic growth should be substantial, rather than a short-lived “flash in the pan.”
We are already seeing early signs: on March 5, the euro strengthened significantly against the dollar, climbing to 1.07 from 1.0240 on January 10.
This movement is driven not just by optimism over fiscal expansion, but also by expectations that increased government spending will fuel inflation—forcing the European Central Bank to adopt a more restrictive monetary stance.
As a result, the euro has recorded its strongest three-day winning streak since November 2022, while 10-year bond yields have risen at least 20 basis points across Germany, the U.K., France, Italy, and Spain.
Markets anticipate that the large-scale issuance of debt over the coming years will create turbulence, particularly at the long end of the yield curve.
German bond yields have reacted, with the February 2035 Bund (2.5% coupon) falling to 98.40 and its yield rising to 2.70% last Wednesday.
However, there is no clear sign that investors are fundamentally reducing their demand for Bunds, despite a slight discount to reflect higher anticipated deficits.
This marks a historic turning point. Germany is abandoning its self-imposed “straitjacket” of fiscal conservatism and embracing debt issuance on an unprecedented scale.
Given Mertz’s statements, a market reaction was expected—10-year Bund yields have jumped around 20 basis points in a single day, mirroring moves in other European government bonds.
The yield gap between German and U.S. bonds has also narrowed to its lowest level since September, with further tightening likely.
German debt? No Panic
However, this is not a repudiation of German debt—unlike the market turmoil seen in the U.K. during Liz Truss’s ill-fated fiscal policy debacle in 2022 or the recent budget concerns in France following the 2024 elections.
In those cases, credit risk spiked. On march the 5th, there was no such reaction in credit default swaps (CDS) on German debt, which have remained stable even as bond yields surged.
A closer look at Bloomberg data reinforces this point. The chart compares the price of 5-year CDS contracts (yellow line) against the yield of the German 5-year government bond (white line).
The CDS price has barely moved, rising from 10 to 12 basis points—insignificant in relative terms—while the Bund yield has surged by 20 basis points in a single day (from 2.20% to 2.40%).
Furthermore, there is no strong correlation between these two variables, as shown by the near-zero blue correlation line in the sub-chart.
This suggests that the rise in German yields was not due to concerns about excessive debt issuance deteriorating Germany’s debt-to-GDP ratio or increasing sovereign risk.
Instead, it reflected higher inflation expectations over the next five years—the only plausible driver for a sharp move in yields when CDS prices remain unchanged.
But is it realistic to assume that a €500 billion multi-year debt program alone would trigger a 20-basis-point jump in Bund yields overnight? This reaction seems exaggerated, if not outright hysteria, from bond investors.
Moreover, who can say with certainty that such a large-scale fiscal stimulus will generate sustained inflationary pressure? That remains to be seen.
One thing is clear: this €500 billion in new debt will not destabilize Germany’s debt-to-GDP ratio.
Consider the numbers:
- By the end of 2025, Germany’s GDP is projected to reach €5.8 trillion.
- Currently, Germany’s debt-to-GDP ratio stands at 62.5%.
- If GDP remains unchanged over five years (a highly conservative assumption), the €500 billion intervention would increase the debt-to-GDP ratio by 8.6 percentage points, bringing it to 71.1% by 2030.
However, Keynesian economics teaches us that public investment—when directed toward productive projects—drives economic growth by creating jobs, spurring further investment, and increasing national savings.
When public debt funds real, productive investments, it is considered “good debt”.
If we assume a modest 2% annual GDP boost from these investments, Germany’s economy would expand by 10% over five years, reaching €6.4 trillion by 2030.
Under this scenario:
- The €500 billion in additional debt would represent an increase of just 7.8 percentage points in the debt-to-GDP ratio.
- Germany’s debt-to-GDP would rise from 62.5% in 2025 to 70.3% in 2030—still well within a sustainable range.
Would this increase jeopardize Germany’s AAA credit rating? Absolutely not.
In conclusion, the The reaction that the market had during the March 5, 2025 session appears overblown, creating rare opportunities to enter high-quality European sovereign bonds at attractive yields.
Key instruments to consider include (data related to the March 5 session):
- Bund 2.5% February 2035: Trading at 98.40, offering a 2.70% yield (+20bps vs. prior day).
- OAT 3.20% May 2035: Trading at 98.24, offering a 3.40% yield (+21bps vs. prior day).
- Bund 2.50% August 2054: Trading at 89.80, offering a 3.03% yield (+25bps vs. prior day).
- Netherlands 2.50% 2034: Trading at 97.30, offering a 2.85% yield (+20bps vs. prior day).
DISCLAIMER
The information and opinions expressed in this article are for informational purposes only and should not be used as the sole basis for investment decisions. Investors retain full discretion and responsibility for their own financial choices, based on their individual risk tolerance and investment horizon. This article does not constitute an offer or solicitation to invest.
Original article published on Money.it Italy 2025-03-05 17:49:54. Original title: Questi titoli di Stato oggi sono un’occasione grazie al sell-off sul Bund
