He expects Bund prices to crash “with vigor” either when the market realizes they are not so safe after all and that Germany’s public sector finances are vulnerable to trouble in the banking system, or “when the banking crisis comes to a quick head and safety no longer commands such a premium.” Weinberg pointed out 10-year Bunds had seen an appreciation of some 22 percent since the start of the problems in Greece.
Yields have dropped from 3.8 percent.
He argues that if “real” 10-year yields of 2.5-3.5 percent are normal and reflect trading before the Greek crisis, then – taking inflation into account - normal 10-year yields ought to be in the 4.5-5 percent range.
An increase in the inflation rate generally leads to higher interest rates, and when new bonds are issued in a higher interest rate environment they will have a higher yield.
“So figure the ‘risk premium’ included in the Bund yields today is 300 to 350 basis points. When the snap comes, and yields return to normal levels, prices will drop by about 35 percent,” Weinberg said.
He added that a capital loss of 228 billion euros ($281 billion), 35 percent of the 652 billion euros in Bunds outstanding at an average duration of about seven years, was “probably a high estimate” but he believes it is indicative of what could happen when Bunds are no longer considered a safe asset.
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