Are German bonds all that?

North Rhein Westphalia (NRW) goes to the polls this weekend.

The political tension surrounding the elections is about many seats Angela Merkel’s party may lose.

NRW is Germany’s most populous state and it’s GDP equals 22% of Germany’s total and if it were a country, it’s economy would be the world’s 14th largest. With a GDP estimated to be in the range of $550 billion and it carries a debt of approx. $230 billion, which is quite a debt for a state with a population of 18 million.

Actually, its Debt to GDP ratio is quite conservative when compared to the whole of Germany’s which runs at around 85%.

While Germany’s GDP to Debt ratio is below the 105%+ marks that Greece, Italy, Portugal, Ireland and the U.S. carry, it is worth exploring why German debt is more revered than France’s.

France’s Debt to GDP ratio is close to Germany’s, yet their 10 year bond has a yield of 2.80% while Germany’s commands a “safe haven” status of 1.52%.

Why do German 10 year bonds trade at 1.52% and why did investors recently accept a negative yield for their short-term deposits?

Is it because Germany’s debt obligations are perceived to be safer than France’s?

For some background, it’s important to note that European countries gave up their right to control their monetary base when they adopted the Euro. It is the European Central Bank that establishes interest rate and monetary policy.

Yet the Bundesbank has said that “it won’t allow inflation to rise”. Hmm, so if inflation rises in Germany (currently at 2% p.a) and the Bundesbank can’t set interest rate policy – how does it propose to control inflation? Perhaps it can influence it’s government to decrease government spending. I don’t think this would help it’s safe haven bond perception.

A German 10 year bond yield 1.52% seems to be close to the low end of its logical range. If inflation rises, German federal and leading state government debt rises and its GDP purchasing power weakens, I can see these bond yields tripling before they halve.

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