What are Bunds?
Bunds are a type of government bond from Germany. The word “Bund” is short for “Bundesanleihen” which means “federal bonds” in German.
Key facts about Bunds
- Bunds are issued by the German federal government
- They are used to borrow money to pay for government spending
- Bunds are denominated in euros, the currency used in Germany
- You can buy Bunds that mature (need to be paid back) in 4 to 30 years
- The 10-year Bund is the most common and is considered the benchmark
- Bunds pay interest to investors every year until they mature
How Bunds are issued
The German government issues new Bunds in two main ways:
Through a group of banks
The government picks a group of big banks to form a “syndicate”. This syndicate buys all of the new Bunds from the government. Then the banks in the syndicate sell the Bunds to investors. This is called underwriting.
Through auctions
The government can also issue Bunds through special auctions called Dutch auctions. In a Dutch auction, the price of the Bunds starts high and goes lower until all of the Bunds are sold. Investors say how many Bunds they want to buy and at what price. The investors who are willing to pay the highest prices get the Bunds.
Why investors buy Bunds
Investors buy Bunds for a few key reasons:
Safety
Bunds are considered very safe investments. Germany’s government is seen as financially stable and unlikely to default (not pay back the money it borrows). Investors know they will very likely get their money back when the Bund matures.
Steady interest payments
Bunds pay investors interest every year. This gives investors a predictable stream of income. The amount is set when the Bund is issued and doesn’t change.
Ability to sell before maturity
Investors can sell their Bunds to other investors before they mature. There is a large and active market for Bunds. This makes them a “liquid” investment that can be converted to cash if needed.
Bund prices and yields
The price and yield of a Bund have an inverse relationship. This means when the price goes up, the yield goes down. And when the yield goes up, the price goes down.
Bund prices
The price of a Bund can change over time based on various factors:
- Supply and demand in the market
- The interest rate set by the European Central Bank (ECB)
- Economic conditions and outlook for Germany and Europe
When more investors want to buy Bunds, the price goes up. When more investors want to sell, the price goes down.
The ECB sets key interest rates for the euro area. When the ECB raises rates, Bund prices usually fall. When the ECB lowers rates, Bund prices usually rise.
If the economic outlook is good, investors may sell Bunds to buy riskier investments like stocks. This lowers Bund prices. If the outlook is bad, investors often buy Bunds as a safe haven. This increases Bund prices.
Bund yields
The yield is the annual return an investor earns for holding a Bund. It is based on the Bund’s interest payments and its current market price.
For example, let’s say a Bund has a face value of €1000, pays 1% interest per year, and has a current market price of €980.
The annual interest is €10 (1% of €1000). The current yield is about 1.02% (€10 / €980).
If the Bund’s price rises to €1020, the yield falls to about 0.98% (€10 / €1020). If the price falls to €950, the yield rises to about 1.05% (€10 / €950).
The importance of 10-year Bunds
The 10-year Bund is the most widely watched and traded. It serves as a benchmark for other European bonds and is seen as an indicator of economic conditions.
As a benchmark
The yield on the 10-year Bund is used as a reference for setting interest rates on other debt, like corporate bonds. When companies or governments borrow money, they often have to pay a higher interest rate than the 10-year Bund yield.
The extra interest over the Bund yield is called a “spread”. The riskier the borrower is seen, the higher the spread.
For example, let’s say the 10-year Bund yield is 1%. A strong company with low credit risk may pay only 1.5% to borrow for 10 years (a spread of 0.5%). A weaker company with higher credit risk may have to pay 3% (a spread of 2%).
As an economic indicator
Many investors see the 10-year Bund yield as a sign of how the German and European economies are doing. A rising Bund yield may mean investors expect faster economic growth and inflation. A falling yield may mean investors expect slower growth.
Comparison to other government bonds
Bunds are just one type of government bond. Other European governments and the US government also issue bonds. Comparing the yields gives clues about how investors see the different economies.
German Bunds vs. other European bonds
Investors generally view Bunds as the safest European government bonds. So Bunds usually have the lowest yield.
Bonds from other countries like Italy or Greece are seen as riskier. Their yields are usually higher than Bunds. The gap in yields (the spread) can show if investors are more or less worried about those countries’ economies and ability to repay debt.
German Bunds vs. US Treasuries
US government bonds are called Treasuries. They are also seen as very safe. The yield on 10-year Treasuries is another widely watched benchmark.
Historically, 10-year Treasuries tended to yield more than 10-year Bunds. This meant investors usually saw the US economy as stronger than Germany’s.
But this isn’t always the case. Sometimes Bund yields are higher than Treasuries. This might happen if investors think the US economy is weaker than Europe’s or that the US political situation is riskier.
