US embassy cable - 05FRANKFURT5048

UNCLAS SECTION 01 OF 02 FRANKFURT 005048 
 
SIPDIS 
 
SENSATIVE 
 
STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA 
STATE PASS FEDERAL RESERVE BOARD 
STATE PASS NSC 
TREASURY FOR DAS LEE 
TREASURY ALSO FOR ICN COX, HULL 
PARIS ALSO FOR OECD 
TREASURY FOR OCC RUTLEDGE, MCMAHON 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EUN 
SUBJECT: German Finance Agency Issues USD Bond 
 
 
T-IA-F-05-030 
 
This cable is sensitive but unclassified.  Not/not for 
Internet distribution. 
 
  1.   (SBU)  Summary: The German Finance Agency made news 
     with its first borrowing in US dollars since World War II, a 
     cool USD 5 billion.  The move was taken in response to Asian 
     demand and to save money, but does not mark the beginning of 
     a regular dollar-borrowing program by the German Agency. 
     German Bunds continue to be a benchmark issue in a euro bond 
     market that has grown to be larger than the USD market. End 
     Summary. 
 
First USD Borrowing Since WWII 
------------------------------ 
 
  2.   (SBU)  On May 24 the German Finance Agency made news 
     with its first borrowing in USD since World War II. The 
     German Finance Agency, formerly part of the Bundesbank, is 
     the borrowing agent for the German Government and reports to 
     the Ministry of Finance.  The USD 5 billion, 5-year issue 
     was over subscribed with bids hitting USD 13 billion to 
     yield 12 points over comparable US Treasuries.  Market 
     participants speculate there could be more such German USD 
     offerings in the pipeline. 
 
  3.   (SBU)  The head of the Agency explained to us that the 
     USD issue was undertaken to save the Finance Ministry money, 
     a principal objective of the Agency.  During a spring trip 
     to Asia and the Middle East, he detected strong demand for 
     USD assets and a desire to diversify away from US Government 
     paper.  Asian investors with whom he spoke thought the Euro 
     was over priced and expected the USD to recover.  He 
     reported that, in the event, Asian investors purchased 60% 
     of the issue and 50% of the total went to central banks. 
     The low interest rate allowed the agency to save 13 million 
     euros, even after the issue was fully hedged so that it has 
     only euro liabilities. 
 
Other New Features Yet to Come? 
------------------------------- 
 
  4.   (SBU)  New euro sovereign borrowing techniques have 
     begun to attract attention.  France has inflation-linked 
     bonds and in February issued a 50-year bond.  The French 
     bond had an initial size of 3 billion euros but was doubled 
     when it attracted euro 19.5 billion in bids.  The spread to 
     the 30-year French benchmark issue was a mere 3 basis 
     points, a feature that European Central Bank President likes 
     to cite as confidence in the long-term value of the euro. 
 
  5.   (SBU)  The German Finance Agency is likely to issue an 
     inflation-linked instrument and has just about completed the 
     necessary technical work, but the agency head doubts it 
     would produce any cost savings.  Such instruments can be 
     cheaper than straight bonds in environments where 
     inflationary expectations are high but measured inflation 
     actually falls.  Inflation expectations are low in Germany. 
     In fact, the Bundesbank never did an inflation-linked issue 
     as it would have conflicted with its stated objective of 
     price stability. 
 
  6.   (SBU)  He doubts the Agency would do a 50-year bond 
     issue.  There is little liquidity in that segment.  He 
     pointed out that most of the French issue was placed with 
     hedge funds, not long-term investors like pension funds. 
     That said, he agrees with the Bank for International 
     Settlement's (BIS) assessment that there has been strong 
     demand for longer-dated instruments.  This reflects a desire 
     for higher yields and some recent supervisory requirements 
     for institutions, such as pension funds, to match better the 
     duration of their assets and liabilities.  In fact, the 
     German Finance Agency has extended the maturity structure of 
     its borrowings, doing more 29- and 30-year issues than the 
     Bundesbank. 
 
Growing Eurobond Market, but Still Obstacles 
-------------------------------------------- 
 
  7.   (SBU)  The euro bond market continues to grow and now 
     surpasses the US market, according to the agency head.  BIS 
     statistics show that in 2003 and 2004 the value of the gross 
     issuance of euro-denominated international bonds and notes 
     topped those denominated in USD.  In the first quarter of 
     2005, euro issuance of these instruments totaled $572 
     billion compared to $306 in USD.  While gross euro issuance 
     is typically strong in the first quarter, the BIS notes this 
     year's extraordinary 22% advance reflected favorable 
     financing conditions to restructure balance sheets, 
     particularly in growing markets. 
 
  8.   (SBU)  However, the euro bond market for sovereign 
     issues is not really a unified market, according to the head 
     of the Agency.  Some European countries offer tax breaks to 
     residents when they purchase local government bond issues, 
     others maintain a market- maker system requiring 
     participating banks to support their government issues by 
     providing liquidity in the market.  The German Finance 
     Agency is unique in that it has no primary dealer system, 
     but buys and sells directly in the market and offers no 
     special features to traders.  German bonds are the market 
     benchmarks and are much in demand.  "I like competition," he 
     concluded. 
 
 
  9.   (U) This report coordinated with US Embassies Berlin 
     and Paris and USEU. 
 
  10.  (U) POC: James Wallar, Treasury Representative, e-mail 
       wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)- 
       7535-2238 
 
Bodde