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August 28, 2014 6:01 pm
It takes one to know one. In the first half of this year, Japanese investors bought more French government bonds than US Treasuries, according to Bank of America Merrill Lynch.
Yet French bonds yield 100 basis points less. Meanwhile, 10-year German Bunds are 150bp dearer than US Treasuries, the largest such spread in eurozone history. The difference that may matter more for a buyer from Japan is that, at below 1 per cent, this German debt is still yielding more than comparable bonds issued by Japan. And not least – a Japanese investor might from bitter experience bet that deflation in the eurozone shall ensure even a low German yield stays positive in real terms for potentially years to come.
It is very tempting to go with experience. Each fresh piece of eurozone economic data shows inflation falling below 1 per cent, and lending to businesses still contracting. Few saw Japanese deflation coming before the event. Thus, buy Bunds. The trade also appeals if the European Central Bank buys sovereign bonds as a quantitative easing programme. Such purchases will mostly be Bunds if the ECB weights them according to eurozone countries’ share of its capital.
But the ECB may not want to buy peripheral country bonds, which have come close to needing restructuring in the past, and may again. Asset-backed securities may be the ECB’s target.
So buy bank stocks, not Bunds. If QE did buy up sovereign debt, that would raise the value of banks’ own holdings, improving capital. But if the ECB buys asset-backed securities instead, that too would be positive for banks’ capital because it would remove riskier assets from their books. Finally, long-term loans from the ECB, which start next month, will reduce their funding costs. The Euro Stoxx Banks Index trades below book value; every German Bund below three years trades at a negative yield. One is a cheaper play on QE in Europe than the other.
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