Exclusive: Transcript of Econostream’s Interview with German Finance Agency’s Tammo Diemer

3 April 2023

- Diemer: Don't have to make changes to auction calendar just because energy prices lower
- Diemer: Inversion of German yield curve has no impact on our issuance activities
- Diemer: Want to be a predictable issuer and want to be an issuer that focuses on auctions
- Diemer: Will do whatever is needed and is in our hands to support functioning of Bund market
- Diemer: Need to create additional incentives to attract new investors to green segment

By Xavier D’Arcy – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream recently with Tammo Diemer, member of the Executive Board of the German Finance Agency:

Q: It's a big year, we're seeing a lot of issuance from a lot of countries, and Germany is no exception. Maybe you could just give us an impression of how your operations have gone so far?

A: 2023 started very well. We've already executed 28 auctions. We had very good bidding behaviour from the members of the Bund Issues Auction Group with an overall average bid to cover ratio of 1.7, which is well above last year's average. And we already executed one syndicated transaction. The quality of the order book was extraordinarily high. And 37% of this 30-year issue went to central banks outside the euro area, which is very unusual in this long maturity bracket. This indicates how well this bond was received. Overall, a very good start.

Q: Why was there that demand from central banks?

A: It’s not a change. It was a strong emphasis of those central banks that are already active in the long bracket.

Q: This year you have €539 billion issuance planned. That was announced in December of last year. Much has changed since then, the picture regarding energy and economic growth is a bit more positive than expected. Is that having an influence on your work?

A: Part of our funding requirements for 2023 are expenses for subsidies for energy prices. From the very beginning, it was uncertain what amount is going to be needed for these subsidies. Therefore, our funding plan also includes flexible instruments next to our issuance calendar such as secondary market sales of bonds that we hold in our own holdings and repo transactions, money market transactions, where we use our own holdings as collateral. The fact that energy prices are lower means that we can use our flexible instruments to a smaller extent. We don't have to make any changes automatically in our auction calendar just because energy prices are lower.

Q: One of the big themes recently has been the amount of inversion in the German yield curve. Some of it might have been pared back in recent days, but it's been at multi decade highs, what impact has that been having?

A: None. As a permanent issuer, the Bund does not act opportunistically on certain curve situations. We distinguish between two aspects of the structure of the yield curve, one aspect is the long-term behaviour of the yield curve. This long-term ‘structural shape’ of the yield curve plays a role in our funding strategy. In particular, we have an emphasis on the very long end of the curve, and the short end of the curve. Since we want to take advantage of the shape of the yield curve, which tends to have quite high yields in the middle (dimensions around 10 and 15 years) and lower rates, on a relative basis, at the front end of the curve, and at the very long end of the curve. This long-term structure has an impact on the way we steer our refinancing activities. A short term change in the yield curve doesn't have any implication in our near term funding activities.

Q: So you wouldn't say there's a section of the curve that in any way concerns you or maybe displays more advantages when you look at it today?

A: If you’re referring to the inversion between 10 and 30 years, today it is actually normalised. The fact that the curve has been inverted for the last month really just encouraged us that this emphasis on the long end of the curve was also a right decision from that perspective. It's positive feedback for us. But it has no strategic implications.

Q: S&P data shows the biggest amount of short positions against German government debt in quite a long time. Does that has an impact on your activities?

A: No. It's part of our role. German government bonds are the benchmark for the euro area. It’s not a bet against the Bund if a market participant goes short. They simply express an interest rate opinion. It is in the Bund curve, in our segment, where you can express an opinion in the most efficient and most reliable way.

Q: It comes with the territory of being the benchmark issuer.

A: Exactly. In fact, nothing to complain about, it's the opposite. I mean, if a market participant goes short, then he or she also provides liquidity, and liquidity is a central characteristic of an interest rate benchmark.

Q: Before the pandemic, Germany had been very predictable as an issuer, then we saw the beginning of syndicated issuance, and now also dual ISIN auctions. This shows more pragmatism rather than predictability previously. Do you see yourself going more in this direction? Or do you think you would maybe go back to how things were before the pandemic?

A: The Bund is still a predictable issuer. Even for those multi ISIN auctions where we offer two bonds. One of those two bonds, in particular in the 30 year and 15 year segment, is already known beforehand. We publish for the full quarter, one of those two ISINs. We decide a week before the auction what the second ISIN is going to be. We interview market participants and pick a suitable second ISIN to meet with capital market interest. There is still a lot of transparency and predictability in our capital market approach. We added these elements of flexibility due to the fact that the volatility was high in 2022, and is still high in 2023. It is slightly easier for market participants to cope with this volatility if we use this flexibility to fit with capital markets' or market participants' demand. This is something we will review, as always. I can't say what's going to happen for 2024. It's unlikely that we will further extend this flexibility, however. We want to be a predictable issuer and we want to be an issuer that focuses on auctions. As you rightly said, we added four syndicated transactions not only last year, but also this year and in 2021 we did two syndicates. The number of syndicates is going to be under review for 2024.

Q: And the key variable in that will be the volatility.

A: It is a key variable. The amount of funding needs for 2024 can be expected to be smaller than 2023. And therefore we go, step by step, maybe back to situations that we know from 2019 and before.

Q: Some segments of the repo market came under strain last year. Do you think that, following the action that the ECB took and you took and everything that's happened now, the potential for volatility in this area has subsided?

A: For us, and for the whole euro area, it is of utmost importance that the market for German government bonds functions well. We will do whatever is needed and whatever is in our hands to provide and to support this functioning. As of today, the price discovery process in German government bonds works very, very, well. As of today, I can't see any need to have extraordinary measures similar to what we did last year.

Q: The government has run down its deposits very strongly lately. Is this a seasonal effect? Or is this something that's more structural?

A: Since the beginning January, we had more outflow than inflow coming from our capital market refinancing activities. Without money market operations, without our repo activities, we would be short in our account, rather than long as we have been for the full year 2022. We do more repo transactions than needed to cover this cash need. We do this because we are of the opinion that this amount of additional collateral, this amount of additional securities is actually needed for the functioning of the Bund market. We still have a cash surplus on our account, since we do more repo transactions than actually needed to cover it. Now we have an option beginning 1 May to either leave it on our Bundesbank account or do reverse repo transactions in order to invest it. This is decided on a purely economic basis. So if there are better options to actually invest it, we will do this. If the rate we receive in the money market is very close to the rate of €STR minus 20bp, there are also good reasons to leave it on the Bundesbank account.

Q: On the question of whether it's seasonal or structural, I'm guessing you're saying it's more seasonal. It's a temporary development, this running down of deposits?

A: It's a typical pattern, and this is not only true for Germany, but the typical budget pattern is that you tend to have more outflows in the first half of the year and to have more inflow in the second half of the year.

Q: Regarding green bonds, you're planning a new 10-year and then a further point along the long end. Which maturities do you think would be most attractive for that?

A: It's not decided yet, we will decide at a later stage, but it will be a green sibling of an already existing conventional bond. This could be one of our outstanding 15-year papers, or one of our outstanding 30-year papers. In the latter case, it would be the 2053.

Q: German green government bonds are less liquid than their vanilla peers. This isn't the case for other issuers. If you look for example, at KfW, their green bonds are actually more liquid than their vanilla ones, What factors do you think explain this difference in liquidity?

A: The trading volume in our green bonds compared to their conventional siblings is smaller. The reason for the differences described is probably the superior liquidity of conventional German Government securities. It is therefore hardly surprising that a relative difference is visible in the green twins compared to conventional German Government securities. For example, bid offer spreads in the secondary market are higher in the green segment compared to the conventional segment. The reason for this is the outstanding volume is smaller, we have typically a larger amount of held to maturity investors. The need for a secondary market trading is smaller.

The overall trading volume in green government bonds is by far higher than it is in the segments you mentioned. For the issuers you mentioned, the trading volume is comparable between their green instruments and their conventional instruments. But, in our case, the trading volume is in general on a much higher level. The conventional bonds are in a league of their own.

Q: Another quite interesting aspect is this premium, which the green bonds trade at over their vanilla counterparts as well. This is narrowing now, do you think we might see this premium disappear?

A: This will not disappear. We will see movements in the ‘greenium’ in the future as we have seen them in the past. Our goal and our intention is to interest investors that already exist for German government bonds to actually buy green. When we offer supply in the green bond market, we want to make sure that there is also demand from the capital market - additional demand. We don't want to offer supply and hit existing demand. Our goal is that investors, which are today on the sidelines of the green bond market, actually jump into the green bond market. We have to offer something and we offer them price transparency, the ability to do with a green government bond, what they can also do with a conventional German government bond and the ability to liquidise them in a similar way to conventional bonds. This makes them attractive.

Q: And what's the advantage of attracting new investors to the segment?

A: To provide added value for the environment, for our planet. For us, it's important that the green element has a value.

Q: Inflation swaps are trading still very high. Do you think this is just rising term inflation risk premia? Or do you think there's perhaps a de-anchoring of expectations taking place?

A: I think that inflation expectations are still anchored at 2%. Market participants see developments and have the need to hedge against inflation in the stock market. And therefore, I would say that this risk premium you were referring to in the inflation swap market is higher than in the years before.

Q: Rising interest costs for the German government have gained a lot of media attention recently. How do you personally, and how does the DFA deal with the increased scrutiny of your work?

A: We have to take interest rates, inflation rates and additional financing needs as they are. In doing so, we manage the debt portfolio over time. In previous years, when interest rates were extremely low, we steered our portfolio towards the long end of the curve. However, we have also borrowed a large part of the high additional financing needs since the pandemic in the short term. Specifically, over the past eight years we have significantly increased our issuance of 30-year bonds. The last year we had a normal volume of 30-year bonds was 2014, when we issued €6 billion of 30-year bonds. Since then, we have steadily increased this amount and introduced a 15-year segment. This year, it will probably be more than €30 billion in 30-years, plus about €20 billion in 15-years.

Q: I guess part of these huge numbers that have been going around is also an accounting quirk in the way in which the German government deals with interest payments, and its funding activities. Does that also make the headline numbers look very different to what the underlying situation is?

A: In the year 2021, we had €4 billion of interest expenditures. This number was positively influenced from the fact that we issued above par. If you issue above par, then our accounting - the German Public Sector Accounting - which is cash flow based, means that the amount which is above par is actually an interest income. Therefore, the interest expenditures are reduced. This 'agio' effect reduced the interest expenditures significantly in 2020, 2021. In 2022, and in particular into 2023, we not only issue at par, but sometimes even below par and therefore we have additional interest expenditures coming from these issuance activities.

Q: Do you think it might be more useful to change the way in which this is accounted for?

A: We are transparent on this. So if you look in the annual funding report, the so called ‘Kreditaufnahmebericht des Bundes’, you see precisely the amount of ‘agio’ and ‘disagio’ effects not only of this year, but also how it is distributed over the upcoming years.