Trading German Bunds and Spreads

The European Sovereign Debt Crisis in 2009 led to a number of new terms entering the financial lexicon, ranging from concepts like austerity to acronyms like PIIGS. German bonds, known as "bunds", may have been relatively niche on a global level before the crisis, but investors now monitor so-called bund spreads to determine how well eurozone countries are doing relative to its strongest member.

In this article, we'll take a look at what German bunds are and how investors can use bund spreads to monitor the health of various eurozone economies.

Bunds and Bund Spreads

German bunds are simply sovereign bonds that are similar to Treasuries in the United States (the term "bund" is German for "bond"). These bunds are commonly sold in two-year, five-year, ten-year, and thirty-year increments, as in many other developed Western countries.

The yields paid to investors on these bunds are indicative of financial conditions both in the country and in the eurozone. Investors nervous about the country's future or its future obligations to the eurozone may demand higher returns on their investment and thereby push bond yields higher, while those seeking safe-haven may be willing to accept lower yields. Bund yields may also be influenced by the prevailing interest rates and monetary policy set forth by the European Central Bank (ECB).

The difference between the German bund's yields and those of other countries are known as "bund spreads". For example, if Germany's 10-year bunds are yielding 1.3% and Spain's 10-year bonds are yielding 5.5%, then the bund spread with Spain would be 4.2%. 

In the eurozone, Germany is seen as the largest and most stable country, which means that its bunds are treated as the gold standard for comparison. Higher bund spreads are therefore associated with greater risk for the country being compared, while lower bund spreads tend to signify less risk for the country being compared since the same interest rates and monetary policy apply throughout.

Reading Into Bund Spreads

Germany's bunds came into focus during the European Sovereign Debt Crisis, since they provided an easy way to calculate performance. Struggling eurozone countries saw their bund spreads widen, as their borrowing costs grew at a faster rate than Germany's. The financial media often reference these spreads to highlight countries struggling with yields.

The most popular bund spreads to watch are the 10-year bunds, since they fall between short-term and long-term bonds. But, the duration of the bonds can also provide useful insights into investor sentiment across various time horizons. For instance, short-term bonds may signal that things are fine, but long-term yields increasing could be a sign of trouble ahead.

Finally, investors also watch German bunds themselves (without comparison) to gauge whether or not the market is seeking a safe-haven. For instance, negative yields on the 2-year bunds may suggest short-term investor anxiety. In the case of negative yields, investors are actually paying the country to house their money for fear of loss elsewhere.

Finding and Trading Bund Spreads

Investors looking for access to bund spreads to assist in their analysis of eurozone members can find the information in a variety of places. A good place to start is the Bloomberg Rates & Bonds section, which contains the latest rates for major eurozone economies, as well as several other influential economies around the world for comparison.

Traders looking to make directional bets on bund yields can do so using Eurex's Euro-Bund futures, which represent the benchmark German 10-year bunds. Accounting for more than one million of the seven million contracts traded per day, the derivative is one of the most dominant contract traded on the Eurex derivatives exchange.

The Bottom Line

German bunds represent a key element of the eurozone's debt markets, both to compare against other countries and to gauge investor risk tolerance. Traders may use this information to make directional bets or simply assess the riskiness of their portfolios.