Frankfurt It was a giant leap: The yield on ten-year US Treasuries rose from 0.82 to 0.92 percent on Monday. The trigger was the news that the two pharmaceutical companies Biontech and Pfizer will soon bring an effective vaccine to market. Investors switched to risk-taking: They sold government bonds that were considered safe and mainly bought stocks. As a result, bond prices fell, and in return the yield on government bonds rose.
This development was also evident in Europe: the yield on ten-year government bonds moved from minus 0.62 to minus 0.51 percent, the corresponding Italian paper from 0.64 to 0.74 percent.
Development initially stabilized again on Tuesday. But Christian Kopf, Head of Bonding at Union Investment, assumes that the greater willingness to take risks will continue to determine developments. Michael Ganske, emerging market expert at the US fund company, sees a similar situation T. Rowe Price, “Longer term support for risk assets.”
But that means first of all that bonds with low risk and long residual maturities could come under further pressure. “Due to the economic recovery, we are cautious with the long maturities,” says Kopf.
On the other hand, corporate bonds and interest-bearing paper from emerging markets should also benefit from the willingness to take risks. Felix Herrmann, Blackrock’s investment strategist, sees opportunities in European bank bonds, for example. “These are cyclicals, and that’s pretty good for them if there is an economic recovery in the coming year,” he says. Among other things, Kopf relies on real estate companies.
Among the emerging markets, he prefers Asia to Latin America. The countries in the Far East benefit from falling raw material prices. They also have the corona pandemic under control, which is fueling the economic recovery. The Union Investment expert will find paper with a yield of around four percent in hard currency there.
Kopf assumes that short-term interest rates in the US will hardly change. Because they are determined by the US Federal Reserve (Fed), which shows no signs of tightening the monetary reins in the foreseeable future. The long-term returns should move downwards, however, so that the differences between the maturities are smaller.
Kopf goes into detail: “The gap between two-year and 30-year-old papers is currently 140 basis points,” he explains, or 1.4 percentage points. In the past, this range reached a maximum of 200 basis points. This time, the expert expects an expansion to 160 to 180 basis points.
The example makes it clear: With bonds, it is not just the amount of interest that matters, but also the differences in different terms. Professionals can bet that these differences will increase. Or as Kopf puts it in technical jargon: “We expect the US curve to become steeper in the next twelve months.”
He also expects returns in the US to grow faster than in Europe. Conversely, he believes that the difference between Germany and Italy is melting away somewhat. He therefore went “long” in Italy and “short” in Germany in his funds, buying Italian government bonds and betting on lower prices for German securities.
More inflation again
Inflation is a major issue for bond investors. In Herrmann’s view, this risk is still underestimated by many investors. If the economy picks up again after the pandemic has subsided, he believes that prices in Europe and the USA will well exceed the central banks’ inflation target of two percent. The monetary politicians have indicated that they will tolerate this for a while.
In addition to the hopefully better economy, Herrmann mentions a special reason for rising prices. “We hear from companies we speak to that they are changing their supply chains,” says the Blackrock expert. To be on the safe side, corporations prefer to produce closer to their sales markets – but that can be significantly more expensive.
However, higher inflation means that real returns, i.e. after deducting inflation, will fall in the coming year. Kopf sees it similarly. If the short-term interest rates of the central banks in the euro area remain at minus 0.5 percent and in the USA at 0.1 percent, he expects a decline in real yields in the euro area from minus 1.5 to minus 1.7 percent and in the USA from minus 1.6 to minus 1.9 percent.
This shows that despite higher reported returns, it will remain difficult to make money with interest-bearing securities.
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