A few months ago, it seemed Germany’s ego couldn’t get any bigger. The country’s joblessness rate had fallen to its lowest levels since German reunification in 1990, and its small Mittelstand businesses, the backbone of the German economy, were skirting the Eurozone meltdown. Now, events in the bond markets are giving the Germans yet another reason to sing their own praises. The Bundesbank managed to auction 3.9 billion euros worth of six-month debt at a negative interest rate yesterday. That means investors, for the first time in history, were so eager to finance Germany’s debt that they paid the country to do it.
The reason? For starters, rising interest in Germany’s debt is a bet against the euro. The auction came on the heels of yet another Merkozy summit in Berlin on fixing the Eurozone crisis, which, as usual, yielded nothing new. And there are more signs of stress in the Italian banking system, which threaten to bring down its economy along with the rest of Europe. There are also some technical forces at play. Investors had already been trading Germany’s short-term bills at negative interest rates in the secondary market, i.e. in post-bond-auction trading. In response, Germany’s central bank tweaked the rules to allow the same negative yields to occur through their auctions. The hope, presumably, was to push back against the bum rush of investors that have scooped up short-term German debt at a positive yield at auction and then flipped it over to other investors at a negative yield. That might explain why Germany’s short-term bills have been a lot more popular lately than its long-term bills, a phenomenon that has rattled markets. For example, the lack of appetite for German 10-year bonds in late November (Germany failed to sell some 40% of the issuance) drove up its 10-year yields by 7% and prompted speculation that Germany’s bond markets were joining the upward spiral of debt-ridden neighbors like Italy, Spain, and France. Many viewed rising German bond yields as a sign the euro’s end was finally upon us.
But the opposite trend doesn’t bode any better for the Germans or greater Europe. Negative yields, after all, represent a flight to safety. That investors are throwing their money at Germany, even as other Eurozone countries struggle to get credit, shows just how serious the crisis has become. Banks are parking record amounts of cash with the European Central Bank rather than lending to each other, which can only serve to slow Europe’s already struggling economies. And with ratings agency Fitch threatening to downgrade Italy by end January, the flight to safety will only intensify as the pool of top-quality short-term debt shrinks. Since Germany is flush with free cash, there’s no better time for the country to launch a fiscal stimulus that would get Europe growing and quell investor fears. After all, German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed in their latest tete-a-tete that their rescue plan should include a “second pillar” to drive growth. And yet all Merkel has offered on that front is to fork over some “best practices” in regulating labor markets to its flailing neighbors. Such squishy solutions are bound to amount to zilch. All while Germany turns a profit for sitting on its heels.