Key takeaways:
- After Bund yields soared on Germany’s spending plans, global volatility has brought them back down.
- Shorter maturities are in favor as investors position for ECB rate cuts.
- The Bund market remains small compared with US Treasuries.
Amid escalating trade tensions, German fiscal stimulus, and diverging central bank policy between the US and eurozone, German sovereign bonds have become a preferred choice for risk-averse investors. The yield of the benchmark 10-year Bund, which started the year around 2.1%, surged in March before falling in early April and is currently trading around 2.48%.
Despite high demand, investors expect Bund yields to remain elevated as Germany’s ambitious spending plans kick into gear.
“German Bund prices have been volatile over the last few months because multiple forces are at play at once,” says Shannon Kirwin, manager research analyst at Morningstar. “On the one hand, expectations of increased fiscal spending and more debt issuance are pushing yields up, while on the other hand, weak economic growth and the ECB’s rate cuts are pushing yields down.
“At the same time, the Trump administration’s economic policies and trade war have shaken investor confidence in US Treasuries as the ultimate safe-haven asset, and many have looked to German Bunds instead. That has helped fuel a rally in Bunds since April.”
Pressure on US Treasuries Helps Bunds
The US bond market has meanwhile come under renewed pressure as President Donald Trump’s new tax bill gained traction in early June. Investors worry the legislation could add more than $3 trillion to the deficit over the next decade. Persistent inflation concerns and policy uncertainty are further weighing on sentiment.
Kirwin says that interest in Bunds may continue as long as doubts about US creditworthiness and growth persist. “That trend is likely to reverse if investors regain comfort with US Treasuries or if growth and inflation in the eurozone pick up meaningfully. Also, the recent trade war headlines have taken attention away from Germany’s defense spending plans, but as these come back into focus, long-term Bund yields could rise.”
Hakem Saidi, senior portfolio manager global bonds at BayernInvest, agrees: “The era of cheap money is over. In view of rising issuance volumes and geopolitical uncertainties, an interest rate of 3% on 10-year German government bonds appears to be the new normal—not the exception.”
Bunds are back, but not as a risk-free autopilot investment, he says.
“Investors in 10-year bonds are currently seeing slightly positive real yields again. However, with growing government debt and high interest rate volatility, this is not a return to the old order, but the beginning of a new regime.”
According to DWS, Bunds have regained appeal thanks to an improved risk/reward profile, especially compared with US Treasuries. “Their solidity, the steepness of the Bund curve compared with US Treasuries and the generally higher yield level all argue in favor of Bunds in our opinion,” according to Vincenzo Vedda, chief investment officer at DWS.
Will German Bunds Rival Treasuries?
“We currently do not see German government bonds replacing US Treasuries as a global safe haven,” says Bastian Freitag, head of fixed income in Germany at Rothschild & Co Wealth Management.
In his view, there are two factors behind this: first, there is no structural shift in favor of the eurozone, and secondly, the market for German government bonds is simply too small. “The daily trading volume for US Treasuries is between $600 billion and $1 trillion—at least 10 to 20 times what we see for German government bonds.”
Still, Freitag sees potential for the asset class: “What we are indeed seeing is the possible beginning of a diversification of currency zones.” For international investors, creditworthiness is not the only factor they consider. More important is the question: Which currency do I want to hold—and how expensive is it to hedge the currency risk, if it needs to be hedged.
While euro bonds are often unattractive for dollar-based investors once currency hedging costs are taken into account, especially compared with yen or dollar-denominated instruments, Bunds remain attractive to euro-based investors. “It is the most liquid market in the euro area, and Germany is one of only three countries with a AAA rating,” Freitag adds.
Morningstar DBRS, for instance, assigns a AAA rating only to Germany, the Netherlands and Luxembourg within the eurozone.
Thomas Romig, CIO Multi Asset at Assenagon, is less enthusiastic about long-term German government bonds. “We are skeptical of government bonds for two reasons—we do not expect inflation to fall as sharply as it did in the 2010s. And this means that real yields will remain low.” In addition, government bonds generally have a long duration. “When we invest in bonds, we prefer corporate bonds with shorter maturities, where the risk/reward ratio is better,” he says.
In addition, government bonds no longer offer reliable protection against equity volatility. “Until March 2021, there was a negative correlation between equities and bonds. Since then, this ‘insurance effect’ has disappeared,” he adds. Correlations between the two asset classes have been slightly positive for the past years.
While the yield curve has steepened this year, meaning that longer-dated Bund yields have risen more sharply than those of short-dated bonds, the steepness is not enough to justify long-maturity Bund investments. “The interest rate differential between two-year and ten-year German government bonds is currently only 0.6%. That is not attractive for long-term investments—we would only consider it if the spread were above 1% over 10 years.”
European asset flows also show the preference for shorter-duration bonds as the ECB nears the end of its rate-cutting cycle. Investor demand for short-term euro government open-end and ETF bond funds domiciled in Europe has picked up this year, with net inflows reaching a multiyear record of €1.8 billion in April, according to Morningstar Direct data. Meanwhile, flows into vehicles that hold eurozone bonds of various maturities have not shown a positive trend this year.
Spreads Between German, Southern European Bonds at Multiyear Lows
Despite volatility elsewhere, eurozone spreads have remained tight. As of June 10, the spread between Italian BTPs and 10-year Bunds had narrowed to 0.91 percentage points, the lowest since early 2021. French and Spanish spreads have also compressed.
Rothschild’s Freitag interprets this as a telling sign of today’s market sentiment toward risk.
“We are in a phase where risk assets are performing very well—the DAX is close to all-time highs. In my view, the generally higher risk appetite is the main argument for the good performance of eurozone peripheral government bonds. In addition, there is little headwind from the peripheral countries.”
