Change in tax regime in Germany: Bunds return to the market
10 MAR, 2025
By Tomasz Wieladek
Author: Tomasz Wieladek, Chief European Economist, T. Rowe Price
On Tuesday evening, the German government had its "whatever it takes" moment. The anticipated 500 billion euro infrastructure fund and exemptions for defense will significantly increase the issuance of Bunds. This radical change will permanently alter the way Bunds are traded.
At the moment, much of the Bund stock is still owned by the public sector. Foreign central banks own about 30% for reserve management purposes, while the Eurosystem owns about 25% following past QE policies. The private sector owns less than 50% of the circulating stock. But the demand for Bunds is very high. This means that the behavior of the Bund on the bond market has been significantly distorted in the past, with Bunds often falling into negative territory. In the past, despite markets being willing to buy them, the government did not move and kept the supply limited. But the situation has clearly changed with Tuesday's announcement. Today, Bunds will likely be subject to a strong sell-off and in the future will start to be traded more in line with other safe haven bonds. This has important implications for Eurozone sovereign bonds and global bond markets.
The Bund is the foundation of the Eurozone. It is the risk-free rate and the safe haven during market stress phases. In fact, during the fear phase of a possible Eurozone recession in 2019, even before the pandemic-era QE, the demand for Bunds was so strong that yields paradoxically fell into negative territory. Much higher Bund yields will significantly increase the financing costs for all other Eurozone sovereign states. The spreads on Bunds of the most indebted economies, such as Italy, are already very narrow. It is unlikely that they will fall much below current levels. If the new long-term bond yield level for the other major Eurozone countries is now 4-5%, this will have significant implications for the debt sustainability of these countries. In fact, it is likely that with more Bunds to buy, markets will put more pressure on these countries to reduce their huge debts, through tax increases or public spending cuts.
The yields of Bunds are also the anchor of global bond markets. Germany has by far the best fiscal fundamentals not only in Europe, but among the major markets globally. These characteristics mean that all other bonds, including those of the United States, are valued in relation to Bunds. Even if Bunds will now become less scarce compared to other markets, Germany will continue to have the best fiscal fundamentals, even with the large debt expansion announced last night. Since many global bond yields are traded in relation to Bunds, the action of the German government is equivalent to increasing the global risk-free bond rate. Even US Treasuries, historically the center of all bond markets, could over time undergo a significant sell-off in response to higher Bund yields.
