faq
For the first time in twelve years, the yield on ten-year federal bonds is more than three percent. But what are federal bonds actually? And what does the increase in yield mean?
The yield on ten-year federal bonds jumped above the three percent mark for the first time in twelve years. At its peak it reached 3.02 percent – the highest level since 2011.
What are federal bonds?
A bond is a security that entitles the holder to receive certain interest payments each year and to receive the full principal amount back at the end of the term. The issue or increase in such investments works via auctions. Certain domestic and foreign commercial banks can submit bids within a certain period of time.
After the deadline, the responsible finance agency GmbH allocates the bonds depending on the respective bid. The buyer can ultimately keep it himself or sell it on at a premium – for example to institutional or private investors. The owner of the bond can then trade it daily via the stock exchange. German government bonds are considered very safe because rating agencies give them the top rating of AAA.
Why are there government bonds?
By issuing bonds or bonds, states borrow money from investors for several years and pay interest on them. According to the Basic Law, Germany is obliged to balance the balance of income and expenditure. If taxes are not enough to cover costs, he has to take on debt to finance the budget. The German national debt consists largely of listed securities. These include federal bonds.
Why do we pay particular attention to ten-year federal bonds?
The federal government offers various papers that differ in terms of interest rate and term. The classic federal bonds are those with a term of seven, ten, 15 or 30 years. Ten-year bonds are most commonly issued and traded. The reason: Because every country has papers with this term, they are internationally comparable.
The financial world is particularly focusing on the yield on the ten-year bond that was last issued. Because it is the most traded, it reacts fastest to news in the world. Your return is published daily by the Deutsche Bundesbank.
How is the return calculated?
The return is the effective interest rate on a bond and is therefore a measure of the success of an investment after the agreement expires or upon sale. One aspect is the running time. There is more interest on longer bonds because investors are free of their money for longer – with all the risks. However, the interest rate and price are crucial for the return on a federal bond.
If a bond is worth 100 euros when it is issued and has an interest rate of three percent per year, the interest is also the annual return – in this example it would be three euros. However, this calculation assumes that the investor holds the bond until maturity. However, the securities are constantly traded on the market and the price changes constantly. If many investors throw their securities out of their portfolio, the price falls. When demand increases, it climbs up. This has consequences for the return.
If the rate falls from 100 to 90 euros, the interest rate is based on the new rate and the return increases accordingly to 3.33 percent. Yields and prices develop in opposite directions on the bond market. If prices fall with an interest rate fixed for the entire term, the returns for new investors increase – and vice versa.
How have returns changed recently?
For years, the yield on ten-year federal bonds had been negative, and the state had even made money from taking on debt because investors had to pay negative interest rates. At around the beginning of last year the return was minus 0.18 percent.
But since the end of the zero interest rate policy, it has continued to climb. While the return was still 1.4 percent at the beginning of July 2022, it broke the round mark of two percent the following September. This morning, the yield on the most recently issued federal bond even rose to over 3.0 percent, making it the highest it has been in twelve years.
Why is that?
Expectations play a big role in bond returns. If the key interest rates of the European Central Bank (ECB) go up, higher interest rates for federal bonds are also expected. Because investors hope for better returns in the medium to long term, they sell existing bonds. This causes the price to fall and the return to increase. In September, the ECB Governing Council decided to raise interest rates for the tenth time in a row. Further increases are not ruled out.
Inflation is also crucial. The promise of repayment and the increased fixed interest rate in no way compensates for the high price increases that have been going on for months. If inflation is higher than the bond yield, investors ultimately suffer a loss – even if the interest rate and thus the yield on federal bonds rise nominally. Therefore, some investors sell their securities and the lower demand causes the yield to rise.
What are the consequences of a return of over three percent?
Investors who are new to ten-year federal bonds currently receive more than three percent per year for ten years – if they hold the product for the entire period. However, the rising interest rates are a disadvantage for those who already own a bond. Because if the interest rate rises, the price of the existing bond falls and you make a loss if you sell it before the end of the term.
The rising bond yields are also bad for investors in the stock market. Because stocks are becoming less attractive compared to bonds. This is one of the reasons why the German leading index DAX temporarily fell below 15,000 points today to its lowest level since March.
The building interest rates are also directly linked to the yield on the ten-year federal bond. Banks primarily refinance their construction financing via Pfandbriefe. Their returns are based on the interest rates on ten-year federal bonds. For this reason, mortgage interest rates have also risen massively. For ten-year financing, this recently averaged 4.13 percent, as data from the Frankfurt-based FMH financial consultancy shows. For comparison: two years ago they were 0.75 percent.
Does the return also play a role for the state?
Not the yield, but the increased interest rates on federal bonds. This also increases the interest burden for the state, which also includes the annual payments for federal bonds or other federal securities. In 2021 it was only 3.9 billion euros. According to the Federal Ministry of Finance, interest expenses amounted to around 15.3 billion euros last year – and the trend is rising. However, the interest rates on current bonds are fixed, so that spending remains stable for the time being and the state continues to benefit from years of zero interest rates.
Only when issuing new papers does he have to pay much higher interest than before and sometimes even a surcharge on the purchase price. In total, the federal government wants to borrow around half a trillion euros from investors this year. Finance Minister Christian Lindner (FDP) recently pointed out that interest costs have now risen to around 40 billion euros per year.
However, the interest burden remains historically low. According to Marcel Fratzscher, President of the German Institute for Economic Research, the state only pays just under one percent of the gross domestic product (GDP) in interest on a debt of 65 percent relative to economic output. One reason is high inflation, which has caused GDP to rise and the real debt ratio to fall. Tax revenue is also crucial for the state budget. And, mainly thanks to high inflation, these were higher than ever since reunification. In 2022, federal, state and local government revenue corresponded to 24.52 percent of the state’s economic output.