May 22, 2012 / 12:50 PM / 6 years ago

Investors seen buying German bonds despite zero return

LONDON/BERLIN, May 22 (Reuters) - Germany will pay no interest to borrow money over two years this week, taking advantage of investor demand for the euro zone’s safest bonds as worries about a Greek euro exit rattle financial markets.

The currency bloc’s powerhouse set a zero percent coupon on a new two-year bond to be auctioned on Wednesday, the Bundesbank said on Tuesday - the first time this has happened on debt of such long maturity.

However, analysts said the 5 billion euros of paper on offer should easily sell as investors seek to shelter their capital in top-rated debt before Greek elections next month.

“There is still a considerable demand for flight-to-quality assets, investors remain very uncertain and what you can’t discount into markets is how (the Greek crisis) will play out,” said Sanjay Joshi, head of fixed income at London & Capital, a $3.5 billion fund.

“It’s not Lehmans going under, this is a country that could go under... and it is an interlinked system across Europe.”

German government bond yields have sunk to record lows in recent days and, with euro zone inflation at 2.6 percent last month, investors are losing money in real terms.

But that has generally not deterred buyers worried that a new Greek government will reject the terms of the country’s bailout, possibly forcing it to ditch the euro. Contagion from a so-called Grexit could pile pressure on other strugglers.

Concerns over Spanish banks, some of which are riddled with bad loans and stuffed with their sovereign’s debt, are also souring sentiment and Spanish and Italian bond yields have risen sharply.

“The capital volatility of (German bonds) versus the capital volatility of other European assets means there will be demand for this paper. It’s a viable asset for those running benchmark funds,” Joshi added.

Demand for German bonds pushed two-year yields in the secondary market as low 0.28 percent last week and some analysts see them dipping below zero.

Yields on some shorter-dated bills are already negative, meaning investors are paying to lend to Germany.

“At the end of the day (two-year) paper is trading with a yield of near zero percent so why not reflect that in the coupon?” said Peter Schaffrik, head of European rates strategy at RBC Capital Markets. “It’s probably not ideal, but on the other hand bills are trading with negative yields and no one is bothering about that.”

Traders said Germany’s new bond was yielding around 1.5 bps in the grey market, where prices are quoted before a bond is issued.

Although some longer-dated auctions have failed to draw enough demand to cover the amount of paper on offer - most recently April’s launch of a new 10-year Bund - demand at shorter-dated auctions has been consistently strong.

On average, bids at two-year auctions this year have been worth nearly twice the amount on offer and the average yield has been 0.17 percent.

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