By Harry Robertson and Nell Mackenzie
LONDON – Investors have amassed the biggest bet against German government bonds since 2015, as the country issues large amounts of debt and the European Central Bank (ECB) talks tough on inflation.
The value of German government bonds on loan rose to 111.1 billion euros ($121 billion) on Jan. 18, according to data from S&P Global Market Intelligence, the highest level since December 2015.
When investors such as hedge funds want to “short” a bond, they borrow it from a broker and sell it, with the aim of buying it back later for less and pocketing the difference. The value of bonds on loan is therefore seen as a proxy for short selling.
Analysts said there are likely technical factors at play. For example, German bonds are commonly borrowed to hedge against risks or to gain access to high-quality assets.
Yet many investors are wary after a recent rally in German debt prices. Gareth Hill, senior fund manager at Royal London Asset Management, said he’s betting against longer-dated European government debt in general, including that of Germany. He cited Germany’s borrowing plans as a key reason.
“There’s going to be much more supply coming, there’s going to be less central bank buying,” Hill said. He said issuance so far this year has been easily absorbed by the market, but “something’s got to give”.
Germany said at the end of last year that it planned record debt issuance of around 540 billion euros in 2023, in large part to deal with the energy crisis. That was up from 450 billion euros in 2022.
The increase comes just as the ECB prepares to cut back its support for the bond market. It will gradually reduce its bond holdings from March, in a process known as quantitative tightening or QT, by letting the bonds mature without reinvesting the money.
The yield on the benchmark German 10-year bond has fallen from an 11-year high of 2.569% at the turn of the year to around 2.25%. Yields move inversely to prices.
“I’m waiting to see another peak, like December, around 2.5%,” said Mauro Valle, head of fixed income at Italy’s Generali Investments Partners, who is positioned against German bonds.
Valle said Europe’s stronger-than-expected growth is keeping the pressure on the ECB to keep hiking interest rates. Higher rates tend to cause investors to demand higher returns on bonds, pushing yields up and prices down.
ECB officials, including President Christine Lagarde, have struck a tough tone on inflation over the last two weeks, saying interest rates have much further to climb.
The ECB has already raised borrowing costs by 250 basis points since July, and traders expect another 50-basis point increase this week.
Kaspar Hense, senior portfolio manager at RBC BlueBay Asset Management, said much of the borrowing of German bonds is likely to do with portfolio management.
“The market is always short Germany, because it uses Germany as a hedge,” he said.
Hense said many bond investors try to reduce the risk that a rise in interest rates will hurt their portfolios by shorting German bonds, which are some of the cheapest to get hold of.
Yet banks also tend to borrow bonds so they have more high quality, liquid assets on their balance sheet around reporting periods, said Matt Chessum, director of securities finance at S&P Global Market Intelligence.
Investors are stepping back into the bond market again after yields rose sharply in 2022, as central banks hiked interest rates to tame inflation, making returns more attractive. Germany’s 10-year yield started last year at -0.2% but has since surged around 240 basis points.
Jim Neumann, chief investment officer at investment advisors Sussex Partners, said he’s encouraging his clients to allocate their money to hedge funds that are taking both long and short positions on government bonds, “to take advantage of the opportunity set stemming from differing central banks moves”.
Cosimo Marasciulo, a fund manager at Amundi, said there is “a window of opportunity to play this theme” of betting against euro zone debt.
He said eventually a slowdown in the United States should catch up with the euro zone economy, potentially pushing the ECB to pause its hikes or even cut rates.
Investors’ short positions have likely contributed to the recent volatility in bond markets, said Pooja Kumra, European rates strategist at Canadian bank TD.
Kumra said short covering, where investors are forced to buy back bonds to close their positions, had probably amplified the recent rally in German debt.
“Whenever positioning is extreme, it does provide volatility,” she said.
($1 = 0.9181 euros)