LONDON German bonds have so far been viewed as the last bastion of safety in the euro zone sovereign debt markets but some prices are beginning to suggest their allure will not be eternal.
A relentless rise in southern European countries' borrowing costs and the hefty premium they pay over Germany overshadowed an unusual development this week -- German yields rose as the euro zone crisis sucked in France and the Netherlands, rather than falling as they did when Italy fell victim.
The yield premium that investors demand to hold 10-year U.S. or UK bonds rather than German debt has shrunk sharply in the past few days as a result, highlighting investors' preference at this point for debt issued by these large non-euro zone countries.
Moreover, while the cost of insuring against an Italian or French default has risen markedly in the past week, the biggest daily percentage rise in the cost of such insurance on Thursday was actually in Germany rather than France or Italy.
"Germany is still the best of a bad job in the euro zone and out of all the members, it still represents the most credible safe haven, but Germany is not immune to this crisis," said Simon Derrick at Bank of New York Mellon in London.
In fact, data on how the bank's clients are moving their money around euro zone bond markets shows the most dramatic shift in investor behavior is related to Germany.
"We are seeing that demand has dissipated for German paper with maturities of one year or more," Derrick said.
GIVING EUROPE A WIDE BERTH
Investors and strategists insist Germany is still viewed very differently to other euro zone countries and that fixed income and credit market prices are far from entering uncharted waters or dangerous territory.
For example, German 10-year yields may have risen by nearly quarter of a percentage point between Tuesday and Friday, to 1.97 percent, but are still far below this year's peaks of 3.5 percent.
Moreover, the yield discount at which these bonds trade to UK or U.S. debt is still well within this year's ranges as are prices on German credit default swaps, which are bought as insurance against default.
But those paid to look beyond intraday moves are far from complacent.
"It is a bit too early to talk about Germany selling off but it is a concern. Ultimately Bunds are not the place to be in the long term and we would prefer (U.S.) Treasuries," Harvinder Sian, interest rate strategist at RBS, said.
"Asian investors are looking at it (the euro zone crisis) and saying that they want to be out of euro assets, and even Bunds."
The steady decline in German bond yields means the balance of risks and rewards is shifting for many investors -- at least for those investment and pension funds who have the option of taking their money out of the euro zone altogether.
For example, Germany offered the lowest interest rate ever at its sale of two-year bonds this week.
The result was such weak demand that the government would have been left with unsold bonds had the Bundesbank not taken back a record large amount for the maturity on offer.
The German debt office declined requests for comment on Friday.
Such investors say Germany's robust government finances won't be relevant if the euro zone crisis ends up leading to either a fiscal union or a break up of the euro zone.
The first outcome would imply higher borrowing costs for Germany while the second would saddle Germany with a new national currency that would appreciate so sharply that it would cripple exporters and therefore the economy.
"We are watching Germany with a bit of concern because of its exposure to the rest of the euro zone and the potential increase in that exposure," said Elisabeth Asfeth, fixed income analyst at Evolution Securities.
"There isn't any outcome to this whole crisis that is positive for anyone, least of all Germany."
Anecdotal evidence from fund managers suggests Asian investors are not the only ones who are looking at the possible outcomes and wondering whether to give the whole of the euro zone a wide berth, rather than trying to pick safe havens.
"We are getting a silent run on (euro zone) sovereigns," said Stuart Thomson, chief economist at UK-based Ignis Asset Management which had 78 billion pounds ($123 billion) in assets under management at the end of September.
"Triple-A (credit rated) benchmarks will soon consist of Germany, Finland and the Netherlands. In that environment, some people are thinking they are better off out of Europe." ($1 = 0.633 British Pounds)
(Additional reporting by Sinead Cruise; Editing by Ruth Pitchford)