TRANSCRIPT: Interview with German Finance Agency’s Tammo Diemer on 24 January 2022
4 February 2022
Q: What do you make of the fact that benchmark German borrowing costs appear poised to enter positive territory sustainably? How does this influence your approach, in particular against the backdrop of recent comments by a colleague of yours that issuing ultra-long debt may be more challenging as interest rates rise?
A: Clearly the actual development of the yield curve does not have an immediate influence on our approach. The calendar is set and we execute it whether interest rates are going up or down. In fact, the budget law fixes a certain amount of interest expenditures for the fiscal year, and we need to calculate this in advance. We do this based on a forward-looking market approach, plus a cushion, so it’s a very mechanical way of calculating expected interest expenditures and is independent of actual developments. The ultra-long segment is an interesting point on the yield curve for a number of reasons. We are absent from this segment, the main reason being that we currently focus on our benchmark maturities. However, for debt managers, ultra-long maturities have a constructive effect on the whole portfolio. We’d like to rein in interest costs and risks, i.e. interest expenditures and the ability to forecast interest expenditures in the future, the actual development of which is our risk as a debt manager. Our debt portfolio brings these two aspects into a balance, and in fact, ultra-long maturities can help produce a slightly more efficient portfolio from that perspective. And on the other hand, we are the benchmark for the euro area. We benefit from the lowest costs in the area and a liquidity premium that investors are willing to pay. In the ultra-long segment, the liquidity is still developing, and therefore, from a relative perspective, the costs seem higher in this segment. So the two sides of the coin are constructive support of the portfolio structure and, as of today, relatively high costs.
Q: May one draw any conclusions from that about your possible plans regarding ultra-long issuance?
A: The calendar we published in December does not contain ultra-long maturities. But on a regular basis, we review this decision. And yes, over the last years, ultra-long maturities have become more and more attractive, but they haven’t yet reached the necessary threshold.
Q: Do you consider reasonable expectations of 0.3% for the 10-year by end-2022?
A: We have no strong view here. It’s actually not part of our thought process to come to a reasonable expectation about this. Our approach is market-based, so on a forward level plus a certain adjustment for volatility. And so it is really not an opinion that leads to an expectation of our interest expenditures, but rather purely a financial mathematical approach.
Q: If pandemic-related developments or anything else unexpectedly increased your financing needs, what would be your instruments of choice to deal with this?
A: There is no general approach that works under all circumstances. In 2020 we had this situation, and the short-term bill market was recognised – as it is today - as a flexible instrument an unexpected supply of which will find demand. So, for a number of situations, this might be an appropriate instrument to look at first when it comes to an unexpected increase of financing needs for the Bund.
Q: Conversely, if surprisingly high growth were to make it clear that your plans exceeded the need, would you adjust, and if so, how?
A: The issuance calendar is published in December for the coming year. In principle, adjustments herein can be made to the next quarter in the event of changes in the funding requirements. Nevertheless, a number of additional even more flexible instruments next to the calendar are also used to cover the funding needs in 2022. One is syndicated transactions, a second is the selling of own holdings to the secondary market, and a third is the repo market, where we are an active player. And last but not least, I’d like to mention that we actually started 2022 over-funded, since we did a bit more funding last year than we turned out to need. So, these more flexible instruments – in the sense that they are not part of the announced calendar – are obvious candidates to be reduced in the event of lower financing needs. Therefore, we would do less repo transactions before we cut the calendar. We would do less selling to secondary markets before we cut the calendar. We might do smaller syndications before we cut the calendar in 2022.
Q: The issuance plan for 2022 said that financing needs remained elevated on account of the continuing pandemic situation. But the economic recovery is seen as just slightly deferred rather than cancelled, with seasonally adjusted real GDP growth projected by the Bundesbank to be 4.2% this year. So why the apparent pessimism?
A: The financing need is the sum of redemptions and the deficit. The deficit is an instrument in the hands of the sovereign and comes with political targets. The growth projection of the Federal Government is certainly also part of the deficit target. So these are all numbers that are determined by the sovereign and by the debt portfolio, and our task is simply to refinance that financing need.
Q: Issuance of green bonds this year is to be of a volume like last year. Is the NGEU making it difficult to find enough green expenditures for the Finance Agency to finance?
A: 2022 is our third year issuing green bonds. We were able to increase the funding volume in 2021 versus 2020, since we had more green assets to be refinanced. Our expectation is that we will have roughly the same amount or slightly more green expenditures from the budget 2021 to issue green bonds in 2022. The green expenditures that will be allocated in the NGEU programme are already identified and are already excluded from green expenditures allocated to the national green bond programme since 2021. Consequently, the NGEU really comes on top and we can continue our green issuance based on other green expenditures. The goal that we pursue when issuing green bonds is to add value to the development of the green market. We think it is of the utmost importance that the financial market provides a reliable and efficient platform for the economy to fund the enormous investments needed going forward to put economic activity on a sustainable basis. Our value here is the reference we offer in terms of the pricing differential between a green financial instrument and a conventional financial instrument. That should help investors and potential issuers navigate through their financing and refinancing activities. Clearly, as sovereign and in particular as Bund, we have a reliable and very cheap refinancing basis for all our expenditures, conventional or green. But we are in a position to issue not only a sufficient volume, but also in various maturities at liquid points on the curve, and making transparent the spread differential between conventional and green bonds helps other issuers find the right refinancing rate. For example, this has been done successfully by our colleagues in Denmark earlier this month. They were able to issue a green Danish government bond five basis points below the conventional Danish government bond yield. Clearly, the fact that there is this benchmark issuer from Germany with a transparent pricing differential between these two markets helps financial market participants price such new issuance. And this is the value that we want to provide in 2022 as well, by making the existing points on the curve more liquid on the one hand, and adding a new maturity point to the curve on the other. This is how I expect we will continue in the years to come, having more and more liquidity in the various existing green German government bonds and adding more and more points to the curve.
Q: How do you regard the most recent decisions by the ECB with respect to asset purchases, and the likelihood that tighter monetary policy is looming?
A: The extensive asset purchasing by the Eurosystem really has an impact on the market for German government bonds. From a yield perspective, that’s intended by this monetary policy. But also from a trading and liquidity perspective. So, a reduced purchase pace would first of all have a positive impact on the tradability of German government bonds.
Q: Do you have any concerns about volatility and spreads?
A: It is our role as benchmark to live with these sorts of market situations, and higher volatility is part of this. An environment of higher volatility makes it more challenging for the members of the Bund Issues Auction Group during the few seconds of an auction when the bidder is not clear about the actual outcome. We try to be as quick as possible so as to reduce this risk, but in volatile times this is an increased challenge for the members of our auction group. But apart from that, market participants have to live with that. A change from very expansive monetary policy into a tightening mode comes with volatility and we have to deal with it.
Q: Concerns that inflation will remain high, even if not as high as now, are increasing. What implications does this have for you?
A: We have inflation-linked bonds outstanding, and we are committed to this market in the sense that we issue a certain amount on a regular basis. And we have done so over the last years, even when demand for inflation-linked products was reduced. We continued to issue inflation-linked bonds even when breakeven yields were below the ECB target, though we reduced the volume then, since we have to expect higher costs when breakevens are below the ECB’s target. But in 2022 we continue to issue inflation-linked bonds. The demand has increased, but we will continue according to our pattern.
Q: What is the likely scale of the sell-off of Finance Agency’s own holdings of Bunds this year? Are expectations of €20 billion reasonable?
A: We do not fix this amount in advance. The gap between the actual financing need in 2022 and the funding that is provided by the calendar is filled by a number of instruments, and the selling of own holdings is just one element. There is no particular target that we already know today. It depends on other elements. For example, how large is the volume that we have already pre-funded? This will be known at the beginning of February. And how large is the volume of syndicated transactions that we execute? This is not set yet. And the repo market is very flexible as well and very attractive from an economic perspective, in particular now, with still strong demand for German government bonds. We have to see what happens over the year and it can turn out that the scale of the sell-off is higher or lower than the €20 billion you mentioned.
Q: Are there specific criteria for deciding what securities/tenors to run down?
A: There are no specific criteria. We tend to be active in bonds that offer a relative value, so we would be offering bonds that would improve our refinancing result.
Q: Will the ECB’s PEPP activity have any influence on this?
A: I’m not aware of the criteria of the Eurosystem for selecting the bonds they purchase, but we see strong demand for high-coupon bonds, and they sort of look particularly expensive on the yield curve. But whether this is really a result of the Eurosystem’s purchase activities, we can’t really say.
Q: What was the thought process behind the absence of 7-year issuance in 2022: too many maturities/lines, not enough demand, something else?
A: The reason is that the funding volume and the outstanding overall portfolio of German government bonds are small compared to the role that we play for the whole euro area. The outstanding US government bonds more or less cover the whole US dollar economy, so the amount of outstanding US treasures is comparable to the GDP in US dollars. Whereas in the euro area, due to the construction of the euro, the outstanding amount of German government bonds compared to the euro economy is significantly smaller. So we have to focus on a number of maturity points and put high volume onto these points to provide a yield benchmark for the whole euro area. So, we will focus on 2-year, 5-year, 10-year and 30-year bonds, and due to the exceptionally high funding volume needed in 2020, we introduced the 7-year and the 15-year brackets, but the goal is really to go back to 2-years, 5-years, 10-years and 30-years. We have taken the first step by no longer issuing 7-year bonds, and we have significantly reduced the 15-year volume in 2022 compared to 2021.
Q: And that can be understood as a preliminary step to ceasing to issue 15-years entirely.
A: In principle yes, but the decision depends on the funding volume in the coming years.
Q: Linker issuance is not increasing in 2022 despite what appears to be high demand. Do you look at this product in terms of asset-liability matching or purely expected costs?
A: We do not apply asset-liability reasoning to our linker issuance. It’s purely a way to diversify our portfolio. As long as linkers provide value in terms of the balance between expenditures and planning certainty, it’s an interesting refinancing instrument.
Q: On December investment calls you are reported to have said that “the gap between net supply and the government's funding requirement will be primarily covered via the sell-off of own holdings as well as the cash balance of c. €60 billion, with the utilization depending on the eventual cash need of the new government.” Is this all valid?
A: Yes. The €60 billion was the best guess we had in December of the pre-funding, and this best guess needs to be confirmed, which will happen at the end of January or the beginning of February.
Q: Are the €60 billion of unused climate-related expenditures already incorporated in your forecasts?
A: These expenditures planned by the government will take place over a number of years, so it is not intended by the government that these €60 billion will be spent in 2022. They may be partially spent in 2022 and partially spent in later fiscal years. That’s the idea of these climate-related €60 billion. If this expenditure takes place, then this needs to be refinanced, and we would rely on our more flexible instruments to do this. This is an amount that would not necessarily lead to a change in our calendar.
Q: The net Bubill supply is negative this year at -€24.5bn (vs. +€41.2bn in 2021). Is a negative net Bubill supply going to be part of your strategy for next year as well?
A: Yes. This can be expected. We’ve been refinancing extraordinary financing needs in 2020, 2021 and 2022 to a large extent with additional bill issuance, and over the next years, it is reasonable – again, from a portfolio management perspective – to shift those short-term fundings into the various longer-term instruments. So, we will sort of spread this over the curve during the next years. And in particular, if we return to balanced budgets from 2023 onwards, you correctly observe that this negative supply will continue over the next years.
Q: What impact do you expect on your activities, should geopolitical uncertainty in the European neighbourhood grow?
A: From my understanding, the actual 10-year Bund yield is a combination of two things. On the one hand, we have higher inflation numbers that need to be reflected in higher yields. On the other hand, we have global uncertainties, including the one you just mentioned here in Europe, but also how China will deal with Covid and in particular whether it will continue to pursue its zero-Covid strategy despite the highly transmissible Omicron variant. So there is uncertainty in the market, and that puts pressure on yields. And in fact, last week the uncertainties were actually dominant and were putting pressure on 10-year yields. If those uncertainties were not also on the table, we would have higher yields than we actually now see.