Don’t expect bond investors to get into a tizzy over the prospect of Germany loosening the fiscal taps.
Analysts at Capital Economics say Japan demonstrates how loose fiscal policy does not necessarily result in skyrocketing bond yields. Though counter-cyclical government spending could prop up short-term economic growth expectations and weigh on the market with fresh debt issuance, it was unlikely to make much difference as long as the European Central Bank sticks to its easy money policy stance.
“Germany’s fiscal policy is unlikely to change the outlook for bonds yields much,” wrote Simona Gambarini, markets economist for Capital Economics, in a Monday note. “Japan’s example illustrates the point that fiscal stimulus alone doesn’t necessarily lift bond yields if monetary policy remains loose – as we suspect will be the case in the euro-zone for the foreseeable future.”
Capital Economics estimates that the German 10-year government bond yield won’t escape subzero levels through 2020.
See: Here’s a lesson from Japan about the threat of a U.S. debt crisis
Since last week, reports that Germany was willing to engage in deficit spending in the event of a recession helped weigh on the country’s government bond market in the last few days after a rally for much of the year. German Finance Minister Olaf Scholz said that Berlin could muster as much as 50 billion euros ($55 billion) to combat an economic downturn.
Market participants said these nascent signs that Germany was rethinking its instinctive aversion to deficit spending helped lift the yield for the 10-year German government bond TMBMKDE-10Y, -8.02% up to negative 0.65% on Monday, after trading as low as negative 0.73% last week.
Until now at least Germany’s well-known fiscal prudence has left investors vying for a dwindling pool of risk-free assets. Slowing global economic growth has also drawn inflows into haven assets, accelerating the sharp slide in long-term bond yields across Europe and Japan.
Yet Gambarini says the initial market response to talk of German stimulus was overdone. Only if fiscal stimulus acted on its own would it produce the market selloff that bond market bears have hoped for. But if the European Central Bank loosened monetary policy in concert, yields were unlikely to gain altitude.
And the ECB is already contemplating another round of bond purchases despite concerns that it has long run out of ammunition. ECB policymaker Olli Rehn said last Thursday it was imperative that the central bank decide on an “impactful” stimulus package at September’s meeting.
Japan’s fiscal deficit spending in the 1990s was instructive because it didn’t produce the devastating rise in yields that market prognosticators had warned against, said Gambarini.
Rather, the 10-year Japanese government bond yield TMBMKJP-10Y, -2.17% , or JGB, fell from 3% in the mid-90s to below zero in 2019 as inflation expectations slumped and, in turn, weighed on expectations for interest rate increases. Years of ultra-loose monetary policy only helped further entrench expectations for interest rates to stay low.
Gambarini also said there was “no evidence” that increased fiscal spending would necessarily lead investors to demand extra compensation for owning debt from an increasingly indebted country.
Speculators and other hedge funds who viewed Japan’s swelling public debt levels as a reason to short the country’s government paper have repeatedly lost money on what has been dubbed a “widow-maker” trade.
Read: 3 reasons bond markets fret about Italy but ignore U.S.’s budget-busting deficits