Over the past year, 3 things were 100% certain. That is that a British or Spanish club was in the final of the Champions League, that the sun rises every morning in the east and that Germany had a budget surplus. However, 1 of these 3 certainties is at risk.
Since 2012, the government in Berlin has been left with tens of billions annually. As a result, the supply of German government bonds is not sufficient to meet the demand. Of course there was an offer of German government bonds issued in the past, but the holders of them were not happy to part with them. If they do, they do it at very high prices. While supply decreases, demand increases. This is due to a number of reasons, such as the purchase program of the European Central Bank (ECB). The distribution key prescribes that the ECB almost 30% of the purchase budget has to be spent on German government paper. Between 2015 and 2018, the bank therefore bought German government bonds worth €518,6 billion.
Buying vs. spent
During this period, the German Ministry of Finance issued securities worth €711 billion. However, this also includes debt securities with a term of less than 1 year; the ECB is not allowed to buy that paper according to the rules. This means that the European bank bought up as many German government bonds as the government issued in Berlin. But, besides the ECB, there are other candidates for the German paper, such as European pension funds. They are legally obliged to buy a large part of their premiums in government bonds of the euro countries with the highest creditworthiness (such as Germany).
In addition, banks and insurers often also had to include German paper in their portfolios. Finally, we must not forget that buying government bonds with a negative interest could still be rational (from an investor's point of view). This price could rise further (and interest rates fall further), turning an apparently loss-making investment into a profitable one. Something that has indeed happened recently.
In short: in recent years, the demand for German government bonds has outpaced the supply. The law of supply and demand teaches us that in such a case the price rises, which in the case of government bonds means that interest rates fall. Not only the pension funds, banks and insurers are buyers in 2019, but also the European Ban. Until further notice, the bank decided to reinvest the proceeds of previous purchases, such as interest income and redemptions of maturing bonds. The imbalance between supply and demand persisted, resulting in falling interest rates. That ratio could change significantly in the coming quarters and years. 1 of the 3 certainties could disappear in the coming years: Germany could face budget deficits for the first time in years.
Black Null
It is nothing new that calls are coming from abroad to let go of the 'schwarze Null' (aim for the budget balance for each year). The OECD, the IMF and many economists have been calling on the country to do this for years. Recently, however, these calls have also come from their own country. In fact, these calls are even coming from the coalition. What has been a thorn in the side of many SPD members since the beginning is the influence of the CDU/CSU in the government. The pursuit of a budget balance or even a surplus is an example of this.
Legally, the government is allowed to incur debts for a maximum of 0,35% of the gross domestic product each year. This is independent of the economic phase of the country's economy. The law also allows the government to be overdrawn if economic growth is low. How deep Berlin may be in red is calculated using a formula. In the event of a boom, however, the intention is to report surpluses.
This policy has been defended in recent years with the argument that it is good to reduce debt in good economic times. Exactly as the law actually prescribes. When economic growth was high, the disaffected wing of the SPD could therefore not object. After all, the ban on overdraft had been included in the German constitution since 2009. However, now that economic growth is cooling (in the second quarter there is even talk of a shrinkage) that part of the party feels stronger and makes itself heard more clearly.
The call to leave the so-called 'schwarze Null' is now becoming more frequent and louder. The death blow could come on September 20, because on this day the German government meets on climate policy. If anything is certain about this policy, it is that it will require a lot of money. The pursuit of the schwarze Null is then an obstacle. The law is no longer tenable, a senior SPD member recently said in conversation with a German newspaper.
Tie debt to climate
CDU/CSU is against abandoning the principle. The party then fears that taking on debt is no longer seen as a taboo, so that everything and everyone will soon be asking for more money. It would therefore not surprise me if the parties, by way of a compromise, tie the incurring of new debts to the plans for climate policy. Keep in mind that allowing budget deficits does not have to be in conflict with the constitutional provision on fiscal policy. After all, the law offers the option of being overdrawn in periods of economic downturn.
Another possibility is that it is not the German government, but the German climate fund that issues a kind of 'green bond'. However climate policy is funded, it seems certain that this discussion about German fiscal policy is loose. This could also have consequences for German long-term interest rates. The coalition was initially unpopular with many SPD members. The SPD suffered a historic defeat in the last election, which many saw as the price of ruling with Merkel. A continuation of that, they didn't feel like it.
German yield curve negative
The pressure to pursue a stimulative policy and thereby make large-scale investments (especially in infrastructure) is now extra strong, because the German yield curve is negative. That while the German infrastructure could use quite a bit of investment. A good example is the mobile network. For example, in many parts of Germany, the availability of 4G is deplorable. In the coming months, the German government must finalize the 2020 budget and send it to parliament for approval. That may change the proposals.
Finally, the raging debate over whether or not the SPD should continue to rule could have repercussions in 2021 (when the next German national elections are on the agenda). If the SPD decides to sit out its current ride on the GroKo rollercoaster, then in 2021 the party could form a left-wing coalition and direct the CDU/CSU toward the opposition.
Politically hot autumn
In short, it could be a politically hot autumn in Germany, with fiscal policy loosening for the first time in years. The accompanying increased supply can alter the supply-demand relationship to such an extent that it can put upward pressure on interest rates. What could also be important is the prospect of more supply in the coming years. The German government is in fact obliged to submit a financing plan for the next 3 years with every new budget. The latest version states that the net need for loans up to and including 2023 is €0 per year. And if we look to the next few years, it is quite possible that Germany will have a left-wing government.
Although a left-wing government in Germany feels right-wing budget wise to other countries, there is a good chance that the pursuit of the black Null will become a thing of the past or at least much less prominent at all costs. Knowing that the Germans will vote in 2021, it cannot be strange for the CDU/CSU to pursue a somewhat more stimulating policy. If, at the same time, the integration of the eurozone deepens, than in the past, German long-term interest rates could take a quick turn.