I am puzzled by the primary market operations performed by Finanzagentur and its agent, the Bundesbank. Consider yesterday auction of the 1.5% bond of the Federal Republic of Germany of 2012 (click for official press release).
My reading is as follows:
The issue volume was 5 billion euro. Bids by primary dealers (institutions that have to take the bonds) amounted to 2.77 billion while bids by banks and other private agents summed 1.16 billion. Total Bids were 3.93 billion, well below supply. The Bundesbank accepted 100% of the bids by the primary dealers and approximately 72% of the competitive bids. Price did not respond because supply was artificially lowered through the retention mechanism: 1.39 billion of Bund were set aside in the account of the Federal Government (I presume an account at the Buba). The result is an average yield of 1.42% on the Bond.
Why am I puzzled? I thought that interest rates in Germany were too low (and in Italy too high) according to fundamentals. If this is true, how are German auctions coherent with a normalization of the interest rate differentials and of the overall monetary policy transmission within the eurozone?
P.S.
Admittedly 5 billion is very small and practically there is a flight to quality (es: Siemens borrows at 0.375% for 2 years). Nevertheless coherence might be a good starting point.
P.S.2
I am told that my labeling of non-competitive bidders as primary dealers is imprecise. Most of them are primary dealers but not exclusively, they are bidders that focus on quantity instead of price and are willing to take paper at the average price.
Wednesday 5 September 2012
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Francesco,
ReplyDeletethanks for your insights on this issue. As you pointed out in earlier posts other countries should adopt a similar procedure. I am not sure how the Bundesbank handles the retention of these Bunds. If it uses the cash holdings of the Federal Government to retain these bonds, then this seems ok. It is just simply managing (i.e., "manipulating") the price of the Bunds to ensure the best possible outcome for the German taxpayer.
It makes sense that it does so because it acts as the agent of the Federal Government of Germany (FGG). It has fiduciary duties towards the FGG - Eurozone macroeconomic policy issues should not be a factor in this. The spread to the debt of other sovereign issuers in the Eurozone is not a part of the remit of the Bundesbank as the agent of the FGG nor should it be.
However, if the Bundesbank loans the money to the account of the FGG so that it can then retain these bunds temporarily then this amounts to temporary monetary financing of the FGG and would be contrary, in my view, to the EU Treaty.
Do you know how the Bundesbank funds the retention of these Bunds?
Regards,
Ricardo