Transcript: Interview with German Finance Agency’s Tammo Diemer on 08 October 2024

23 October 2024

By Marta Vilar – Madrid (Econostream) – Following is the full transcript of the interview conducted by Econostream on 08 October 2024 with Tammo Diemer, member of the Executive Board of Germany’s Finance Agency:

Q: In recent weeks the German yield curve has returned to a positive slope between the 2-year and 10-year bond for the first time since August 2022. To what extent do you take the shape of the curve into account when making decisions on issuance plans?

A: The primary goal when it comes to planning our issuance activities is really to fulfil the requirements of being the yield benchmark for the euro area, and thus to produce enough volume in each and every benchmark maturity to maintain future contracts, etc. And then, if there is some flexibility left when designing the calendar in more detail, then we look at what we call the risk premia, which we read off from the yield curve and its movements. The shape of the yield curve clearly plays an important role here and we can generate a benefit by taking advantage of a particular risk premium. But this is really just of secondary importance from the perspective of setting the calendar.

Q: So you actually do take somehow into account what happens in the curve?

A: Yes, and in particular for the full shape of the curve up to 30 years. Our main driver here is, in fact, the time horizon we take when it comes to taking advantage from the yield curve. The longer your time horizon is, the more important the wings are. So, issuing long-term and short-term debt is of great importance if you have a long-term perspective and want to take advantage of the long-term risk premia. If you shorten this time horizon then you typically focus more on the body.

Q: The annual preview of your issuance plans for 2025 is published in December, in only two months’ time. Can you give us a hint as to what to expect for next year's issuance plans?

A: Only vaguely. We have large maturities that are to be refinanced. If you run the analysis, you will find out that we have something like €350 billion to be redeemed. We will not only refinance this amount, but we will also finance a deficit for 2025, so we will again have a significant calendar to be presented in December. You asked for a particular hint about how it will look. The details are clearly to be presented in December, but there is one typical pattern you may observe over the last years: we extended our short-term bill issuance activities until 2021 and since then we have reduced those short-term issuance activities again. At the end of 2024 we will have an outstanding amount in bills of around €108 billion, coming from €149 billion at the end of 2023. I would be surprised if this number would increase again.

Q: Would you say that next year’s strategy would be more predetermined than opportunistic or vice versa?

A: There is almost no room for us to be opportunistic. We are really following our strategy. From a long-term perspective we may change our horizon as I mentioned earlier, or we may change our product mix. We added 7-year and 15-year maturities four years ago in our calendar and at some stage we may reduce these kind of product types again or add a new product type to our activities, but all of this is pretty long-term.

Q: Given that next year the market is pricing in a steady series of interest rate cuts, with rates currently expected to fall below 2% by late 2025, how do you balance the benefits from being predictable and transparent on the one hand with the opportunities that can arise from being proactive and flexible on the other?

A: The answer is really straightforward. The fact that we are viewed as the reference rate for the euro is a funding advantage. Therefore, it's clear that this strategic approach must have highest priority. There are other German issuers not only with the same rating but also guaranteed by the Federal Republic of Germany, like KfW. But clearly, they come at a spread, even though the credit worthiness is precisely the same and the overall volume is also decent, with around €500 billion in the case of KfW. Our advantage comes from this strategic approach of maintaining the status of the benchmark. Being opportunistic can only take place to a very small extent, since the benefit from being strategic is so enormous.

Q: In which segment would it make sense to be opportunistic then?

A: We are opportunistic in the sense that there is a certain amount of own holdings that we keep in each and every auction. It is well known that it is typically around 20%, but sometimes it's a little bit higher and other times it's a little bit smaller. This might be considered as an element of being opportunistic. In a particular auction we see whether the orders are expensive or whether they are in line with the secondary market. Consequently, the amount of own holdings is the result of a particular auction and is managed to achieve good auction results for the issuer in the long term. Nevertheless, the overall approach is purely strategic, with a calendar for the full year being completely predictable.

Q: The longest German bonds yield more than the underlying euro swap rate. Is this an indication that the market is getting more concerned about the amount of long-end borrowing being conducted and planned or that it has concerns about the long-term creditworthiness of Germany?

A: From our perspective the long-term spread between Bunds and swaps is a result of supply and demand. There are two or three factors that are relevant here. First, we have increased our 30-year issuance activities significantly over the last 10 years. So, 10 years ago we had an issuance volume of, say, €10 billion, and this year, in 2024, we have almost €40 billion. Also, clearly there is no buying activity from the Euro system anymore. Thirdly, we also observe receiving interest in swaps in the long end of the curve from liability driven pension funds. Therefore, from our perspective this Bund swap spread development in the long end of the curve is predominantly a result of supply and demand and also due to the increase in free float in this segment coming from German bonds.

Q: Has demand shifted from one part of the curve to another due to the ECB's rate cuts? How could this impact on your issuance plans?

A: What we observed this year is very strong auctions overall, compared to last year and the year before. Bid-offer ratios are fairly high at 1.5. However, if we look at the bill market, the demand for bills has decreased compared to last year. I'm not sure whether this has to do with yield expectations. But the overall picture is pretty strong, including bills.

Q: Retail investors still have a low share in your investor structure. Would you like to increase their share or are you happy with current figures?

A: From a retail perspective, German government bonds are not very attractive. The reason is that incorporated within the price of a German government bond is the ability to buy and sell very large amounts of several €100 million in one shot. This feature is not interesting for retail investors, but of high importance for institutional investors, in particular central banks, since they have the need to be able to manage their portfolio in big sizes and trade German government bonds in clips of €100 million within a few minutes. That comes at a price, and it makes less sense for a retail investor to pay that price.

Q: Today, October 8, you were expected to issue a green bond with which you plan to achieve your estimated issuance volume of €17-19 billion in 2024, how did this issuance go?

A: Very well. The average bid-offer ratio is around 1.5, as I mentioned, and in today’s auction in the green market it was 2.3. So, significantly higher than for our conventional bonds. There was very strong interest for this particular 10-year green bond. It is our outstanding 10-year green benchmark. The orders resulted in an attractive price for us and a greenium in the primary market of around 1.1bp. Overall, this year we have been able to issue our green bonds in the primary market with a greenium. The bond slightly underperformed last week compared to its conventional twin bond after announcing that we were going to issue this particular bond. But in today’s auction there was strong demand resulting in an auction premium.

Q: Since there’s such a strong demand for German green bonds, last year you had a green bond issuance of €17.25 billion. Do you intend to keep growing the proportion of German issuance allocated to green debt?

A: The amount of green expenditures in the German budget is much larger than the amount of green bonds we issue. The reason for this is that a number of other refinancing tools are in place. So, the Federal budget’s green expenditures are not only financed with green bonds. Green expenditures are also part of the NextGen EU programme, some are steered towards KfW, so that they can actually issue green bonds against it. There are the CO₂ certificates on a European level, from which all European countries get income. This also refinances green expenditures. Long story short, there is a large number of green expenditures in the budget 2024, but there are a number of refinancing tools and we need to shuffle them. It is a bit too early to come up with a number now.

Q: So we can expect a range similar to this year’s in 2025?

A: I'd like to be precise on this, but I can't now. All I'm saying is it's a process, the fiscal year 2024 is not over yet.

Q: Late last year you said that you would stop sales of inflation-linked bonds in 2024. How long do you expect this pause to be and when might you resume the inflation linked-bond sales?

A: We made it clear that the decision to exit this market is a permanent decision. It was a strategic decision to enter this market but there were good and bad developments over this period. We came to the strategic decision to exit the market. It’s a definite exit.

Q: So, this decision was due to signs that demand was weakening?

A: One benefit we wanted to achieve with linkers, which we doubtlessly had, was an improved diversification, not only from an investor type perspective, but also from a portfolio management perspective. We talked about taking advantage of the risk premium earlier and here we took advantage of diversification in the instruments for our cost-risk balance. You can achieve this with linkers since there is only a small correlation to bonds with fixed coupons from a mark-to-market perspective. A linker behaves differently from a fixed rate bond, so there is an obvious diversification. But the linker market comes with a tail risk, which means that all the advantages that you earned over the past decade can be gone within a year or two. When we exited last year we made it crystal clear that we were fully confident that the European Central Bank and the Euro system would be able to cope with inflation developments. That’s not the question. The question is whether every 20 years for whatever reason there might be a situation where inflation is pretty high for a short period of time. And this short period then can damage your whole performance of the last years. Not only this. In this period of time you also have very high budget expenditures due to interest payments on linkers. The predictability of your interest expenditures decreases when you use linkers as a refinancing instrument.

Q: Under no circumstances, not even in the long-term, are you expecting to resume the sales of inflation-linked bonds?

A: I can't foresee any circumstances that would lead to re-entering it.

Q: The economy in Germany is very weak now. It's expected to shrink again in 2024. Are you expecting a recession? What is your take on the German economy?

A: For the last handful of years Germany has had no growth on average. Clearly there are reasons for that. Our economy needed to adapt to the new pricing level concerning energy and clearly this takes some time. We also see huge investments from companies and enterprises to improve their energy efficiency. We reshuffled our energy imports in a significant amount. Our position a number of years ago was much less diversified than it is now. It’s clear that we must further improve. A strong Europe needs a strong Germany.

Q: Do you fear that this economic weakness might trigger a change in Germany’s rating or even in its outlook?

A: No. As far as I understand, the rating is clearly based on a number of positive aspects, be it our diversified and predominantly mid-sized company-based economy, our solid debt structure on the public side, our good and reliable governance and we have a number of positive competitive advantages as an economy. The euro is also a huge advantage for the German economy and the relatively low refinancing rates not only for the state but, as a consequence, also for German banks and companies. There is a spread against the German sovereign yield, but the starting point is very low and it is a competitive advantage compared to other members in the euro area. Therefore, there are still a number of positive aspects, but we need to make them work and lead to growth going forward.

Q: Do you perceive a risk that German debt may lose some of its best-in-class safe haven status in intra-Eurozone sovereign debt markets due to this economic weakness?

A: No. Market participants appreciate the liquidity in the German market, including the futures market. We have a turnover of €250-350 billion per day in the futures market. This is a high amount of liquidity, and no other market comes close to this amount of tradability. This attracts more liquidity. That's the primary reason why from a fixed income perspective we are best-in-class, and there is no indication that this will change. Even though the German economy might be performing poorly, the German Bund market functions well, even better than some years ago. The volume I was indicating has increased over the last years.

Q: And I understand that you don't think liquidity might be at a significant risk because of this economic weakness in Germany.

A: No. Fixed income market participants really want to have a functioning market. Look at other benchmark issuers in other currencies, be it the US, UK or Japan. The shape of the economy is clearly important from a fixed income perspective, but it is not of primary importance. This is different in the equity market. Clearly you want to have an economy where the equity market outperforms. But fixed income works differently.

Q: Many Eurozone sovereign yield spreads have narrowed now versus Germany partly due to the relatively stronger economic performance of countries like Spain and Italy. Would you expect this narrowing in the spread to persist if German activity continues to lag compared to other countries in Europe?

A: Yes. First of all, it is important to recognise and appreciate the development that Spain has undergone over the last year - but also Greece. For us this narrowing is really more of a normalisation, and it is due to both an outperformance of Spain and other issuers and an underperformance of Germany and other issuers. The resulting spread level reflects a welcome normalisation.

Q: So, you don't expect the spread to go back to previous higher levels?

A: No. Normalisation is the basic trend given inflation and spread developments. Of course, any risk-off event would widen spreads again, at least temporarily, as German government bonds always provide investors with a safe haven.

Q: Countries all over Europe have been increasing their spending in recent years, crisis after crisis. But Germany hasn’t. You have stuck to the debt brake. What effect did this have and will continue having on Germany’s borrowing?

A: The debt brake is a positive element from a creditworthiness perspective. It means a government needs to prioritise expenditures and has to fulfil a balanced budget. Investors appreciate such an approach. However, part of the debt brake is the ability to deliver investments. The German government can also provide loans or increase their share in companies or equity pieces in companies; such financial transactions are on top of a balanced budget. So, there are options for the government to provide impulses on parts of the economy and support for infrastructure development.

Q: Are you expecting the ECB’s balance sheet runoff to have an impact on German bonds given the current pace or would an impact only be significant if the ECB were to increase the pace of the balance sheet reduction?

A: This reduction of the Euro system’s balance sheet is positive for the Bund market. This increase in free float clearly makes it easier to trade German government bonds and the repo market functions much better. The market expectation is that it is really a rundown in redemptions and maturities. An accelerated reduction with an active runoff as it happens in the UK is nothing I or market participants expect. That would be a surprise which would likely have a further price impact on German government bonds.