(Bloomberg) -- A widely-watched gauge of the attractiveness of German debt fell to the most negative on record as policymakers discuss borrowing more to fund defense spending.
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The German 10-year bond yield hit five basis points above comparable swaps, the most in data going back to 2007. The difference between yields and swap rates — known as the the swap spread — is an important yardstick of future issuance because bonds tend to weaken relative to swaps as the market anticipates more sales.
While bond investors say Germany’s small debt pile means it has the capacity to borrow more — and crucially, it should do so if that funds long-term investment — they want higher yields to compensate for increased bonds outstanding. The latest leg of the move follows a Bloomberg report that Chancellor-in-waiting Friedrich Merz’s Christian Democrats and the Social Democrats are in talks to quickly approve as much as €200 billion ($209 billion) in spending.
As Germany’s mainstream parties fell short of securing a two-third majority of seats in Sunday’s election, which is necessary to ease the constitutional limits on government borrowing, they are mulling pushing through a vote before the new legislature sits for the first time on March 24.
“The German election aftermath is made more interesting by the twist from Merz that the outgoing parliament could be used to create space for extra borrowing,” according to Citigroup Inc. analysts, including Jamie Searle. “This keeps the near-term spotlight on funding for defense, which looks set to weigh further on swap spreads.”
Merz has promised to ramp up investment in the German military to counter Russian aggression, but he is under pressure to move swiftly because of US President Donald Trump’s determination to force a quick settlement to the war in Ukraine. That’s left the European Union hustling to come up with alternative sources of capital.
“Under geopolitical pressure, politicians are exploring funding options for a military build-up, which validates the market’s cautious approach amid looming supply concerns,” ING Bank rates strategists including Benjamin Schroeder wrote in a note.
Investors had already started to price in the prospect of Germany dialing back its tight fiscal rules following the election, with the 10-year spread with swaps flipping for the first time in November. The 30-year swap spread, the equivalent gauge for ultra-long bonds, moved to more-deeply negative territory at about minus 47 basis points, compared to minus 44 basis points at Friday’s close.