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Flight to safety does not equal flight to German Bunds Anymore

Interest-Rates / Credit Crisis 2011 Jan 06, 2011 - 06:14 AM GMT

By: ECR_Research


Edin Mujagic writes: Mention the words ‘euro area’ and ‘periphery’ and immediately almost everyone will associate that with troubles, strikes, indebted nations and rating downgrades, to name just a few flattering possibilities.

But wait, since when is the term ‘periphery’ reserved for southern and western edge of something or some region? How about north and east? Indeed the prominent Oxford English Dictionary describes ‘periphery’ as ‘the outer limits or edge of an area or object’, meaning all sides. So, overwhelmed with stories in the media on the economic and financial troubles in euro area periphery, one easily, but incorrectly, sees the periphery as a place you definitely do not want to be (or want to be associated with, as was recently shown when politicians from Ireland/Portugal/Spain bent over backwards to ensure investors that their country is no Greece/Ireland/Portugal.

Euro area periphery is much more than Greece, Portugal, Ireland and Spain and also includes the likes of the Netherlands, Finland and Estonia. 

Estonia boasts by far the smallest debt of the euro area and does not even issue government bonds (leading to some technical difficulties at the statistical department of the European Central Bank where you can find long term interest rates for all euro and non-euro countries, except for Estonia where ‘no suitable long-term government bonds available on the financial market’ says the ECB. The central bank in fact had to invest some interest rate indicator in order to have some data on Estonia in the table.) Finland has a long history of budget surpluses during the last decade and the Netherlands have had reasonably healthy government finances as well.

When we talk about that kind of periphery, that is the region you definitely do want to be.
Recently, two investment funds (together they oversee just little over 520 billion USD) have done just that. Legal & General Investment Management and Frankfurt Trust are looking towards the Dutch and Finnish state loans for safety.

Both the Netherlands and Finland boast the highest rating possible, Triple A, just like Germany. But the difference between the two smaller countries and Germany is that Germany is and will increasingly be the main financier of the rescue of the troubles euro area countries. Germany is so to speak the ultimate guarantee of the euro area. That ‘honor’ comes at a huge cost, in any case much higher than the cost for the Netherlands and Finland. With every new rescue operation, German Bunds are likely to be seen as a less and less safe haven. Given the fact that the future of the euro is, in the best case, destined to be uncertain and full of new troubles, German Bunds will most likely lose a lot of appeal they currently have.

How could investors profit from all this? Buying Dutch and Finish bonds is likely to earn some money, but it would not be much, given the already low interest rates. If instead of yield you are looking for safety, then the story changes a lot of course. In that case, those bonds are the way to go and even to prefer over Bunds over the medium to long term.

What could make a handsome profit though is shorting the bonds of the other periphery countries in the euro area (and for real daredevils with a long term strategy, shorting the Bunds). They seem destined to fall in price, both in the near and in medium to long-term future.

Another option is to step out of the euro area but not venture very far as the same time. Given the fact that Swedish bonds are on the same footing as the Dutch and Finnish ones, it is likely that the Swedish krona will gain ground against the euro. So opening a savings account in Sweden and just waiting could earn some serious profits by doing virtually nothing or in any case not much. Obviously, there is uncertainty about the outcome and various risks that have to be considered.

Edin Mujagic, monetary economist at

ECR Research ( is one of Europe’s leading independent macroeconomic research institutes focusing on the main currency and interest rate markets. The ECR reports reach a worldwide audience of sophisticated investors and treasurers and CFO’s within corporations and financial institutions. ECR offers a wide range of research products which are online accessible and updated on a weekly basis.

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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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