Germany's haven status fades

"If the euro region continues, then there must come a time when there is a fiscal union and burden-sharing, and that would make the market think more deeply about the creditworthiness of Germany," said Ralf Ahrens, who helps manage about $20 billion as head of fixed income at Frankfurt Trust.

The discount Germany enjoys relative to the U.S. for 10- year borrowing has narrowed to the least in more than three months after Spain asked for a 100 billion-euro ($125 billion) lifeline for its banks on June 9. Traders of credit-default swaps also are buying protection against the risk of losses on German bonds, with the costs of insuring the nation's debt surging to the most since January compared with similar contracts on U.S. debt, Kazinform cites Bloomberg.

Greece holds an election in three days that may lead to it becoming the first nation to exit the 17-nation currency union. German Chancellor Angela Merkel has resisted calls to ease Europe's debt crisis by allowing joint bond sales, telling German lawmakers yesterday that wider burden sharing and ceding budgetary control "go hand in hand."

Painful Outcome

"There is a greater awareness now that the outcome of this crisis could well be quite painful for the German economy," said Ciaran O'Hagan, a strategist at Societe Generale SA in Paris. "The contingent liability on Germany is rising. The losses we have seen have to be paid for by somebody and there is a sentiment that taxpayers in the rest of Europe are not going escape unscathed."

Ten-year German yields have risen 17 basis points this week to 1.50 percent as of 8:38 a.m. London time, up from a June 1 record low of 1.127. The yield gap to Treasuries narrowed to 11 basis points yesterday, the least since Feb. 28. The gap between 10-year bunds and U.K. government bonds has narrowed to 26 basis points, also the least since February and compared with an average 49 over the past five years.

"We don't want to have too much German interest-rate risk," said Andrew Balls, head of European portfolio management at Pacific Investment Management Co. in London, which oversees the world's biggest bond fund. "There is a big flight to quality premium embedded in German bonds. In the event that the euro zone gets better, these premiums will be unwound and German yields will have to rise. If the situation gets much worse, the money may leave the region all together. We favor cleaner dirty shirts, like gilts and Treasuries."

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