The Changing Face of German Bunds

The Changing Face of German Bunds

By RICHARD BARLEY

Nothing the European Central Bank said Thursday is likely to end the euro sovereign crisis. Although the ECB is to extend an existing three-month liquidity facility and has resumed large-scale purchases of Portuguese and Irish bonds, its policy remains officially unchanged. One result: German Bunds may continue to shed their safe-haven status.

.Throughout the financial crisis, Bunds have been a safe haven during times of volatility. But during the latest phase of the euro sovereign-debt crisis, Bunds have lost their halo. Since the end of August, 10-year Bund yields have risen from a low of 2.11% to 2.81%.

True, that is partly due to growing confidence in economic recovery. But it also reflects concern at the cost to Germany of a rolling euro-zone bailout. When yields on Spanish, Italian and Belgian government debt rose last week, Bund yields rose, too. The beta of Bunds to peripheral bond spreads, which captures the magnitude of relative price moves, has turned positive for the first time since May's crisis eruption, according to Nomura.

Meanwhile, Bunds have sharply underperformed U.S. Treasurys in recent weeks, further evidence that investors are starting to look outside the euro zone for safer assets. And the cost to insure German sovereign debt against default has risen; credit-default swaps on Bunds traded Thursday at roughly the same level as CDS on several leading German industrial companies like consumer-goods group Henkel, a potent sign that markets are beginning to price in credit risk.

These trends are likely to continue. With the Irish bailout failing to calm market nerves over Portuguese and Spanish debt, and the ECB taking ever-greater exposure to risky debt through its bond purchases, Germany and other core euro-zone countries are likely to have to shoulder an ever greater burden to preserve the euro. Indeed, Bunds fell again Thursday even as peripheral bonds rose in response to the ECB purchases.

But for traders, there is a silver lining: One way to read the shift in Bund yields is that the market believes Germany will support its euro-zone partners, ensuring the survival of the currency bloc. That might help support the euro, even if it is bad for Bunds.

Write to Richard Barley at richard.barley@dowjones.com