Against the backdrop of a significant increase in Bund yields over the past week, various commentators and real money managers have voiced their reservations concerning the rising risks to Germany as a sovereign. For instance, PIMCO publicised a recent asset allocation decision to lower its exposure to Bunds, citing a (justifiable) concern over the inexorable rise in contingent liabilities in Germany.
Many now regard Germany as being stuck between a rock and a hard place. If it relents and endorses a fully-fledged banking and fiscal union replete with a universal euro-wide deposit-guarantee scheme then the financial cost will be enormous. Alternatively, if Germany continues to resist the equivalent of financial marriage with numerous bankrupt sovereigns, then the contingent liabilities of funding the rescue facilities will continue to rack up in any event. In addition, should most of Europe’s south ultimately leave the single currency, there is the extremely delicate question of how their national central banks repay the EUR 650bn of TARGET2 balances owed to the Bundesbank. Furthermore, Germany would need to stump up a huge wedge of cash to recapitalise the ECB.
Up until very recently, Bunds benefitted from a very significant risk premium, which has been partially unwound over recent trading sessions. That said there is a danger in being too quick to write off Germany from a sovereign credit perspective. Deutschland’s economic tentacles are truly global, and the national balance sheet remains a strong one, certainly much better than any other major European sovereign. Although some of the arguments now circulating regarding heightened Bund-risk are worth noting, at the same time there is a danger of becoming overly alarmed.