German Bond Auction Fails to Attract Enough Demand

By Kim-Mai Cutler and Anchalee Worrachate

Jan. 7 (Bloomberg) -- Germany’s sale of 10-year bunds lured the least demand in six months as investors shied away from a flood of government securities, raising the prospect of increased borrowing costs for Europe’s biggest economy.

Investors bid for 5.2 billion euros ($7.1 billion) of the bonds offered today, a level of demand that prompted the Bundesbank to retain 32 percent of the securities, according to the central bank’s Web site. European governments want to raise money to finance more than $96 billion in bank bailouts and stave off the worst of the global recession. France may sell 7 billion euros of bonds tomorrow and Ireland began marketing five-year debt today. Spain is also planning a sale.

“I would call this a failed auction,” said David Keeble, head of fixed-income strategy in London at Calyon, the investment-banking unit of France’s Credit Agricole SA. “This was a very poor start of auction season.”

The yield on the 10-year bund, Europe’s benchmark government security, rose four basis points to 3.19 percent by 5:14 p.m. in London. The price of the 3.75 percent security due January 2019 fell 0.34, or 3.4 euros per 1,000-euro face amount, to 104.70. The two-year yield fell 10 basis points to 1.64 percent. Yields move inversely to bond prices.

Germany sold 4.1 billion euros of its 3.75 percent securities due January 2019 at an average yield of 3.12 percent today, the Bundesbank said. The government planned to sell 6 billion euros of the notes, according to Societe Generale SA and ING Groep NV.

The last time the Bundesbank retained a larger share at an auction was on July 2, when it held 2.384 billion euros, or 34 percent, of a planned 7 billion-euro sale.

‘Geared Up’

Under the German auction system, the Bundesbank retains notes and bonds at sales for the secondary market. Without such a system, three out of the four 10-year auctions held last year would have failed, based on a comparison of planned issuance and bids received.

Today’s “auction wasn’t fantastic,” said Padhraic Garvey, the Amsterdam-based head of investment-grade strategy at ING Groep NV. “The market had been geared up for a successful takedown.”

Euro-region governments will issue about 20 billion euros of bonds every week during the first quarter of 2009, up from 10 to 15 billion euros a week during the past two years, according to Societe Generale SA.

“I don’t think this is the beginning of a big negative trend,” Garvey said. “Investors are starting question whether German yields are too rich. Germany is going to have a give a greater premium for investors to take down some of this paper.”

U.K., U.S. Sales

The U.K. is planning an unprecedented 146.4 billion pounds ($221.1 billion) of debt sales in the fiscal year ending March 31. The government today sold 2 billion pounds of 4.75 percent bonds due in 2038. The securities yielded 3.98 percent and investors bid for 1.72 times the debt offered.

The U.S. sold a record $30 billion of three-year notes today yielding 1.2 percent and attracting bids 2.21 times the amount offered. President-elect Barack Obama said yesterday he expects to inherit a $1 trillion budget deficit and that similar shortfalls are in store “for years to come” as the government grapples with a recession and other spending demands.

Yield Spread

The difference, or spread, in yield between two- and 10- year German notes rose today to 155 basis points, or 1.55 percentage points, the highest level since September 2004, amid speculation the ECB will cut its main refinancing rate at its Jan. 15 meeting.

Investors expect the ECB to cut its main refinancing rate by at least 25 basis points, according to a Credit Suisse Group AG gauge of probability based on overnight index-swap rates. The odds of a reduction of 50 basis points rose to 88 percent today, from 72 percent yesterday.

“Investors are reluctant to sell shorter-dated notes a week before the ECB rate cut while supply will hurt longer-dated bonds,” Calyon’s Keeble said.

Two-year notes gained as stocks fell for the first time in seven days, stoking demand for the relative safety of government bonds. The Dow Jones Stoxx 600 Index lost 1.2 percent.

German bonds returned 12.2 percent last year, compared with 13 percent for gilts and 14 percent for U.S. Treasuries, according to Merrill Lynch’s German Federal Government, U.K. Gilts and U.S. Treasury Master indexes.