Shinhan Investment: German Government Bonds Are Top Pick in Eurozone for Second Half

Shinhan Investment Corp. has identified German government bonds as its top preference among Eurozone sovereign bonds for the second half of the year.

On May 7, Ji Baekyeon, a researcher at Shinhan Investment Corp., stated in the report "Overseas Bond Strategy: Eurozone Expansionary Fiscal Policy, Vulnerable Non-German Sovereign Bonds" that "the weakness of non-German countries is expected to widen further compared to Germany," expressing this view.

First, Ji noted, "Following the announcement of Germany's fiscal stimulus package in March, the spread between Germany's 2-year and 10-year government bonds widened by over 70 basis points (1bp = 0.01 percentage points). This widened yield gap has been maintained to date," adding, "It is time to pay attention to whether non-German countries will expand their fiscal policies and to the movements in sovereign bond yield spreads compared to Germany."

He also forecast that "Germany's expansionary fiscal stance is likely to spread to other Eurozone countries," and that increases in defense spending by European Union (EU) member states will be inevitable.

Additionally, he pointed out several factors: the recent decline in support for the Christian Democratic Union (CDU) and Christian Social Union (CSU) coalition, known as the Union, which for the first time has fallen behind the far-right Alternative for Germany (AfD); and the fact that further amendments to EU fiscal rules, led by Germany, would impose political burdens on the ruling party. He commented, "Germany's expansionary fiscal policy may not be as significant as market concerns suggest."

Ji explained, "Even with similar fiscal expansion, the upward pressure on German interest rates is expected to be relatively limited," and emphasized, "It is important to consider the structural characteristics of the euro, which has a smaller pool of safe assets compared to other key currencies. The proportion of safe assets (German government bonds) to the euro's money supply (M2) is about 17%." He added that excess demand for euro-denominated safe assets could partially absorb any oversupply of German government bonds.

He further pointed out, "In addition, credit risk must be factored into the interest rates of non-German countries." Given that the debt ratios of these countries generally exceed 100%, he noted that increased spending could lead to a rise in credit premiums.