More On The German Bond Auction

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 |  Includes: BUND, VGK
by: Cullen Roche

Just to be clear, in my piece earlier today I did not intend to imply that the Bundesbank was directly financing the German government. The article I linked to in Les Echos generated some confusion there. What was clearly odd about the intervention today was the sheer size of the operation and whether this sort of sizable interest rate maintenance can be viewed as “monetization”. Remember, it’s not unusual for the Finanzagentur to retain 10-20% of the auction, but today’s was 40%. Some market participants are trying to play this off as business as usual. I don’t think so. The Economist provides some details:

“In Germany the debt auction process is similar to other countries’. Dealers can bid with size and price. The difference is that in Germany, the Debt Agency (Finanzagentur) will retain part of the new issuance all the time, usually 15-20%, so they do not need full demand to issue. Also, the requirement to be a dealer in Germany means making sure of a minimum allocation across auctions that is relatively low (0.05%), while in other countries this requirement is higher (3% for example in Italy). Germany doesn’t grant greenshoe options to its dealers. Other countries do. A Greenshoe option gives the dealer the right to buy the bonds for a few day after the auction at the same price of the auction. Overall this means that demand for German auctions will tend to be lower—all else equal—than for other countries’ auctions. Since 2008, Germany has seen uncovered auctions 1 out of 5 times. Today’s retention amount was large, 39% of the 6bln target.

The Finanzagentur issued only 3.9bln cash. They gave 3.9bln bunds to the market and kept 2.1bln bonds on their books. In the future they can sell this retention amount into the secondary market, raising cash. You may have read that the Bundesbank bought the unfilled part of the auction; this is not correct. The Bundesbank is not financing Germany; it just operates as an agency for Finanzagentur. It is worth repeating that Finanzagentur always retains part of the bonds, so this part of the process is normal. Today the retention was larger than usual. This is probably due to low liquidity across market, lower incentive to place certain minimum size bids by dealers, and richness of bunds in general.”

We also know from the Bundesbank auction rules that they can reject all bids or “save” the auction via the form they did today. Today, the Finanzagentur (the German debt agency) retained 40% of the auction. They generally retain 10-20% of the auction. They will then sell the bonds on the secondary markets where financing is provided. The Bundesbank explains the maintenance process:

“Bids which are above the lowest price accepted by the Federal Government will be allotted in full. Bids which are below the lowest accepted price will not be considered. Non-competitive bids are allotted at the weighted average price of the competitive bids accepted. The Federal Government reserves the right to reject all bids, or to scale down bids quoting the lowest accepted price, and/or to scale down non-competitive bids. If bids are scaled down, there will be no minimum allotment. Bids which have been submitted on time but which, for technical reasons, have to be considered after the allotment will have no effect on the weighted average price of accepted bids which is relevant for settlement.”

So the Finanzagentur retained a much higher percentage of the issue than usual. Obviously, the European bond markets are drying up to some extent and Germany is no exception. So this leaves many questions remaining. Does this form of intervention help to boost Bund prices and serve as an indirect form of monetization? (My thinking is yes). If the ECB intervened in bond markets, “saved” the bonds and then sold them in the secondary market would this be deemed “monetization”? (My thinking is yes). And how would the Germans react if the other national central banks intervened to this extent in an attempt to suppress their own yields? (My thinking is “not well”). It’s all a bit tricky as you can see and like most things in this inherently flawed monetary system, entirely unclear….

Regardless of whether we deem this to be a “monetization” or a “suspect” response to their own illiquid bond auction, one thing is clear – the situation in Europe is deteriorating as even the most liquid of bond markets are now clearly at risk. The great irony here is that the arrangement in Germany allows them to intervene in their own markets while they frown on the idea of the ECB intervening in markets (although it’s still occurring). Clearly, this is all a political showdown at this point as the Germans don’t disapprove of interventions in their own bond market, but frown on using a supranational entity to save the others. Understandable unless you’re planning on remaining part of a (partially) unified monetary union….