We wrote an article kicking the tires of the German economy, especially considering the present eurozone crisis. We also groped around a bit (not very successfully) for a trading strategy on the conclusions of that article. We cannot believe how we overlooked the obvious one, though.
But before we're getting there, some stylized facts and conclusions (for details see the previous article):
- With all the capital inflows in Germany, the record low interest rates, and the undervalued currency, the German economy is to a considerable extent shielded from the euro crisis in terms of the real economy.
- In fact, this situation has, up until now, produced a booming economy. Unemployment is at decades lows, house prices and wages are risking briskly.
- This is actually a good development as, together with the slump induced wage falls in the periphery, it slowly redresses the competitiveness imbalances that are at the root of the eurozone problem.
However, with the euro crisis escalating, we also noted that:
- Germany is liable for staggering amount of funds should the eurozone derail, all kinds of rescue efforts (loans, guarantees, etc.)
- Should the eurozone disintegrate, Germany is liable to have a rapidly appreciating currency, which is liable to dampen their economic growth quite a bit.
Those liabilities and the specter of a rapidly rising currency in the midst of economic upheaval is likely to have quite an impact on German public finances, and we're really putting that mildly. Whether Germany will continue to be able to borrow at the record low rates in this scenario seems very doubtful to us.
And not only us. Moody put Germany (and other triple A countries like the Netherlands and Luxemburg) on negative outlook:
Moody's said the revisions for the three countries were prompted by "the rising uncertainty regarding the outcome of the euro area debt crisis" and the "increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required." [CNN]
Quite. It further mentioned the possibility of a Greek exit and the threat to German banks because of the ripple effects. But even if the eurozone stays intact
Germany, as the eurozone's largest economy, will likely bear an increased financial burden as further bailout funds are required. [CNN]
Up until now, German bunds has been a safe haven investment with yields at the short end of the maturity spectrum already in negative (real) territory. We wonder for how long. The increased eurozone turmoil is likely to cost Germany substantial additional funds one way or another, while a break-down will lead to an economic crisis and will ravishing Germany's public finances.
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But even if things stay more or less as they are, inflation could very well creep up in Germany. The same capital inflows that led the bund rally also create rising house prices.
Wages are rising briskly, and one could argue the ECB one-policy-fits-no-one interest rates are arguably too low for Germany.
This situation, while helping to rebalance intra-eurozone competitiveness problems, is not unlike that of Spain a decade ago. If inflation starts to creep up, real interest rates become even more negative (further stimulating borrowing and spending), or nominal rates move in tandem.
With the increasing risks and costs in the rest of the eurozone, we think the latter is more likely. Which is why we wouldn't at all be surprised to see German yields start to move up again some time in the near future. There is a small corridor of stable inflation and eurozone tranquility where this wouldn't happen, a sort of German goldilocks, but we don't think that's very likely.
All this leads us to believe that shorting German bund ETF's could be a good strategy. There are four such ETF's:
- PIMCO Germany Bond Index ETF (BUND)
- PowerShares DB German Bund ETN (BUNL)
- ProShares German Sov / Sub-Sov Debt ETF (GGOV)
- PowerShares DB 3x German Bund ETN (BUNT)
Shorting the BUNT one might be a big aggressive, since it's a triple leveraged ETF, although at first sight, the performance is less than what one could expect:
As a proxy, one could perhaps even better short French bond ETF's but alas, we were unable to locate a single one. There is an Italian bond ETF though:
- PowerShares DB Italian Treasury Bond Futures ETN (ITLY)
We would prefer to short French bonds though. Their safe haven status is rather spurious, we think.