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Investors are betting on reforms to Germany’s constitutional “debt brake” as markets brace for increased borrowing by Berlin’s government.
Germany’s 10-year bond has fallen sharply in recent weeks, pushing its yield above the rate on euro interest rate swaps for the same period for the first time, a key indicator in a market sensitive to expectations for future bond issuance.
Tomasz Wiladek, chief European economist at asset management firm T. Rowe Price, said the move ahead of February’s federal election was a sign that investors believed that a snap election would mean debt-brake reform. It is said that it is a sign that they are there. “That, in turn, will mean an increase in issuance.”
Unlike other major bond markets, where so-called “swap spreads” have long been positive in Germany and often traded below zero, investors hold Berlin’s bonds relative to their long-term interest rate expectations. means you have been willing to accept a lower return. Fee.
This unusual feature of the German bond market is due to the relative scarcity of German Bundeswehr, which serves as a benchmark risk-free asset for the entire euro area, and is often in short supply due to the country’s reluctance to borrow large amounts. It becomes.
The debt brake caps new borrowing by the federal government at a procyclical 0.35% of GDP and prohibits Germany’s 16 individual states from taking on any new debt.
The law was written into Germany’s constitution in 2009 and took effect in 2016, but was suspended again during the coronavirus pandemic and after Russia’s full-scale invasion of Ukraine, before being reinstated this year.
But economists have often criticized the rules as being too inflexible.
The system has become a point of contention between the left and right in German politics, with the former arguing that it should be reformed to allow for large-scale investments in areas such as infrastructure, and the latter arguing that the system should be reformed to allow for large-scale investments in areas such as infrastructure. They argue that it is necessary to maintain the system in order to protect future generations from the burden of debt. .
Debt rules were one of the main reasons why Prime Minister Olaf Scholz’s three-party coalition government collapsed earlier this month.
Scholz, a member of the Social Democratic Party, called on Finance Minister Christian Lindner, leader of the fiscal hawkish FDP, to suspend the debt brake to allow for additional aid to Ukraine. Lindner refused, so Scholz fired him. The FDP then left the government.
Scholz, who lost his parliamentary majority, is scheduled to hold a vote of confidence on December 16, paving the way for early elections on February 23, which the opposition Christian Democratic Union is widely expected to win.
CDU leader Friedrich Merz has long considered the debt brake sacrosanct. But last week he said for the first time that reform was possible.
He told a business conference last Wednesday that only a few provisions of the constitution remain unchanged. “Everything else is up for debate,” he said.
The crucial question, he added, was what the new borrowing was used for. “Will we end up spending more money on consumption and welfare as a result? In that case, the answer is no,” he said. “Whether it’s important for investment, whether it’s important for progress, whether it’s important for the lives of our children, the answer could be different.”
Rohan Khanna, head of European rates research at Barclays, said the shift in yields and swaps was the culmination of a broader shift in the German economy from a high-growth, low-borrowing state to a low-growth, high-borrowing state. He said that the economic situation is improving. other euro area markets.
This “reflects the fact that the German bond market as a whole and the economy has become ideologically less special,” he said.
