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German government bonds with their sub-zero yields have lured foreign inflows for four straight months. Talk is that it’s reserve managers from Switzerland and China who are among those paying to lend money to Berlin.

Germany’s 10-year sovereign bond has traded with yields below 0 per cent for the most part since March. It currently yields around minus 0.4 per cent – almost a whole percentage point below year-ago levels.

For most of the time since early August, all German government bonds have carried negative yields.

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It’s an unattractive proposition for most bond investors, even those with long time horizons, because holding negative-yielding debt to maturity means incurring a loss.

But amid signs asset managers and insurers are cutting exposure to Germany, there is evidence of increased foreign buying. According to the Bundesbank, Germany’s central bank, net inflows from overseas accounts turned positive in April for the first time since early 2015.

In July, the latest month for which data are available, such inflows, from investors based in the euro zone and beyond, rose 3.6 per cent year-on-year, the biggest jump since March, 2015.

Separate data compiled by German lender Commerzbank and based on its own internal flows monitor also show overseas buyers increased their exposure to the euro zone’s benchmark bond issuer in the first quarter of 2019 for the first time in more than four years.

That, alongside the steady decline in German borrowing costs – down 40 basis points in the April-July period alone – suggests there are some investors who are not put off by the negative yields deterring other buyers.

“In the end, the puzzle is still incomplete, but it’s fairly safe to conclude from these various data points, that we have seen significant foreign buying in bunds and non-euro based buying in bunds,” said Commerzbank’s head of interest rate strategy Michael Leister.

“And most likely, this is not coming from institutional investors but central banks – particularly in recent months.”

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WHY CENTRAL BANKS?

Reserve managers are a secretive bunch, usually reluctant to disclose details of their strategy shifts, while Germany does not reveal who buys its sovereign debt. But there’s anecdotal evidence to suggest central banks have stepped up.

For one, unlike mainstream asset managers, central banks are less sensitive to outright yields, buying bonds for monetary policy or to hold in currency reserves.

Indeed, the euro’s share of currency reserves edged up in the second quarter to 20.35 per cent from 20.23 per cent in the first, recent data from the International Monetary Fund shows, although the rise is also down to valuation effects.

The euro gained around 1.6 per cent against other major currencies during this period.

“I am pretty sure that most foreign central banks, in their currency reserves, hold a large portion of German bunds and as long as those reserves are growing, there will continue to be demand for German debt,” said Joerg Zeuner, chief economist at Union Investment.

One central bank that has lapped up euro zone assets – especially German debt – is the Swiss National Bank, which central bank-watchers say buys German bonds whenever it ramps up interventions to curb Swiss franc strength.

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To protect its export-heavy economy, the SNB has been crediting the sight deposits of Swiss banks with newly created francs in exchange for foreign currency, usually euros. These deposits expanded to 471-billion francs ($626-billion) as of the end of June, compared with 56-billion francs in July, 2011.

Exchange rates can also offer clues since Swiss franc strength against the euro in recent months has coincided with a surge in sight deposits.

“When the Swiss add to their reserves, there is predictably a flow into bunds,” said Brad Setser, a senior fellow on the Council on Foreign Relations in New York who has tracked international capital flows and central bank reserve policies for many years.

Buying of German bonds by the Swiss central bank in recent years has come on top of European Central Bank purchases for quantitative easing. The ECB renews its bond buying in November.

The China link seems more tenuous, but the country cut holdings of U.S. Treasuries to more than two-year lows in August as its trade war with Washington intensified. While bond analysts are reluctant to go on the record as pointing the finger at China, Beijing might well be shifting some cash into the euro zone, they note.

“The latest data does suggest some Chinese Treasury sales in August – and it is possible thus that China bought some euro area assets as part of a broader rebalancing of its portfolio,” Mr. Setser said.

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As for mainstream safety-seeking investors such as pension funds and insurers who are usually drawn to Germany’s gold-plated triple-A rated debt, they seem to have had enough.

Recent auctions of 30-year German debt have seen weak demand and the German Insurance Association’s chief economist was quoted recently by local media as saying hardly any German insurers were now buying bonds.

As for foreign buyers, Japanese funds have been flocking to U.S. bonds and away from negative yielding securities. They sold a net 374.4-billion yen ($4.5-billion) of German debt in August, after 22.6-billion yen of net selling in July.

“At current yield levels, German and French government bonds are not investable,” said Hiroshi Nakamura, senior manager of investment planning at Taiju Life Insurance.

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