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German Bonds Climb in 2010 as Fiscal Crisis Roils Euro Area

Dec. 31 (Bloomberg) -- German bunds climbed this year, the best performance since 2008, as the fiscal crisis that roiled the euro area’s most-indebted nations drove investors to the safest fixed-income assets in the region.

Top-rated securities from Austria, Germany, the Netherlands, Finland and France led euro-member gains in 2010, while the debt of Greece and Ireland, which sought bailouts this year, had the biggest losses among 26 markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. Bunds slid in the fourth quarter by the most since June 2008 amid signs the global economy is strengthening and concern German costs for helping fellow euro-area states may escalate in 2011.

“There has been a flight-to-quality and Europe has been divided between the haves and the have-nots,” said Orlando Green, assistant director of capital-markets strategy at Credit Agricole Corporate & Investment Bank in London. “The have-nots are clearly the likes of Greece and Ireland, and they needed to be bailed out. The risk going into next year is that this domino effect could continue.”

The yield on the 10-year bund fell seven basis points yesterday to 2.95 percent. It’s down from 3.39 percent on Dec. 30, 2009, according to Bloomberg generic data. The yield increased 44 basis points last year and slid 136 basis points in 2008 as the global financial crisis erupted. The price yesterday of the 2.5 percent security maturing in January 2021 rose 0.56, or 5.6 euros per 1,000-euro ($1,336) face amount, to 96.16.

Greek Deficit

German bonds returned 6.3 percent this year, according to Bloomberg/EFFAS data, compared with a 20 percent loss on Greek debt, a 14 percent slump in Irish securities and an 8 percent decline for Portuguese bonds. Spanish and Italian debt also made a loss as investors demanded increasing yields to own the securities of the euro area’s high-deficit nations.

The region’s sovereign debt crisis took hold at the end of 2009 after Greece’s newly elected socialist Pasok government said the budget deficit was twice as big as the previous administration disclosed. In April, Greece sought a 110 billion- euro loan facility from the European Union and International Monetary Fund after being shut out of debt markets.

As borrowing costs climbed amid a wave of sovereign downgrades that saw Greek debt cut to non-investment grade at Moody’s Investors Service and Standard & Poor’s, Ireland accepted an 85 billion-euro bailout on Nov. 28. That also failed to contain the debt crisis as investor concern deepened that Europe’s stronger nations may be unwilling or unable to foot the bill for future rescues.

Credit Default Swaps

The cost of insuring Portuguese, Spanish and Italian bonds climbed to records this year as investors bet a 750 billion-euro financial lifeline drawn up by the EU and IMF in May wouldn’t be enough to ward off defaults. Purchases of 73.5 billion euros of bonds by the European Central Bank and a delay in its plan to end extraordinary monetary stimulus measures implemented to ease the financial crisis also failed to stem the rise in yields.

The extra yield investors demand to hold Greek 10-year bonds instead of German bunds climbed to a euro-era record of 973 basis points on May 7, the last business day before the EU- IMF financial backstop was announced, and was at 952 basis points yesterday. It began the year at 239 basis points. The difference in yield, or spread, between German bonds and 10-year debt from Ireland, Portugal, Spain and Italy also reached the highest since the common currency was introduced in 1999.

Fourth-Quarter Slump

The cost of insuring sovereign debt more than tripled since the start of the year, according to the benchmark Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments.

Five-year contracts insuring $10 million of debt have climbed to almost $210,000 a year compared with less than $69,000 on Jan. 1.

While investor demand for the safest fixed-income assets during the debt crisis pushed the yield on the bund to a record- low 2.087 percent on Aug. 31, German debt slumped in the fourth quarter. The yield climbed 68 basis points since Sept. 30.

Still, the yield discount for bunds compared with similar- maturity U.S. Treasuries increased to 41 basis points yesterday from a low for the year of 3.9 basis points on Oct. 20 as Federal Reserve asset purchases stoked speculation that growth will strengthen next year. The Stoxx Europe 600 Index of shares jumped 6.7 percent this quarter, up 9.1 percent in the year.

The bund yield may rise to 3.28 percent by the end of next year, according to the weighted average of 17 analyst estimates compiled by Bloomberg. Spain’s 10-year yield may fall to 4.43 percent, a separate survey showed, from 5.48 percent yesterday.

Debt Issuance

Total euro government issues may reach 863 billion euros next year, said Morgan Stanley strategist Elaine Lin in London. While that’s down from 925 billion euros in 2010, it’s “elevated compared to historical levels,” and higher than the average from 2000 to 2008, she said.

“Each auction or each redemption date will be accompanied by significant selling pressure on the respective yield curves,” said Michael Leister, fixed-income analyst at WestLB AG in Dusseldorf, Germany. He expects the 10-year bund yield to reach 4 percent by the end of next year.

“There’s a great deal of political uncertainty, as well as a constant risk of negative ratings headlines,” Leister said. “Even at these levels, we still see potential for spreads to widen again.”

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