by Christian Kopf, guest author of Euro am Sonntag
EFinally positive returns again. That is the positive side of the price slide that has swept through the international bond markets since the beginning of this year and has led to deep red numbers everywhere. After interest rates seemed to have been firmly cemented at or even below zero for many years, this stabilization has now broken. The reason is the high inflation as a result of the sharp increase in economic demand after the corona pandemic, but also as a result of the Ukraine war. What is painful for investors now also has tangible consequences for the Federal Republic of Germany: for maturities of around two years or more, the German state has to pay something again if it wants investors to provide it with fresh money.
And the need is high. The Ukraine war is driving up spending – now a special budget of over 100 billion euros has to be financed for defense. All of this is no longer available for free. For example, in early May, for the first time since 2014, the Federal Republic of Germany has to pay almost one percent in interest for investors making money available to it for ten years. But that doesn’t mean that the seemingly golden age of borrowing at negative interest rates is over for the federal budget. Up until May this year, the Federal Republic of Germany had issued bonds with a volume of over 60 billion euros with a negative yield.
Higher coupons lure investors back into the market
Nevertheless, the development of the past few months is also important for investors in Germany. Because in the euro zone, the European Central Bank will probably raise its key interest rate again at the beginning of July for the first time in eleven years. The environment of extremely low interest rates should therefore be a thing of the past – unless the Ukraine war escalates. However, this means that investors can once again achieve returns in the safe haven of the euro zone. But it takes a while before this actually remains in the depot as real income. Inflation is currently still far too high and the loss of purchasing power cannot be offset by the coupons on safe government bonds. However, the upward pressure on inflation will ease over time and weaken next year.
The prospects for bond investors are therefore significantly better than they were just a few months ago. The market – and thus current yields – is already pricing in several rate hikes. The risk that government bond prices will continue to fall at a comparable pace after the biggest slide in prices for decades is rather low. The economy in Europe is suffering from inflation, and growth is currently slowing down significantly, also due to persistently high energy prices as a result of the Ukraine war. This means that the pressure on the ECB to raise interest rates further should decrease in the future. It is not only the economic environment and the need for a safe investment that should then ensure that prices do not fall into the abyss. The higher coupons are also luring investors back into the market, which should support prices – even though the ECB is stopping buying government bonds.
Safe havens on the bond markets therefore have better prospects again. Even higher yields can be found in the European periphery – but the risks are also higher there. Investors should not forget that higher yields in the euro area do not come for free. The other side of the coin is rising financing costs for governments and companies. The credit risk is therefore becoming more important again as a decision-making factor in investments.
Especially in an environment of weak economic performance, investors will take a more critical look at who is better able to service their loan interest and who is worse off. Germany is relatively solid here. The European Union will also not be able to avoid taking on more debt in order to achieve greater strategic independence in energy supply and the green restructuring of the economy. But for countries with a higher debt ratio, such as Italy, things could soon get tough again. After the end of the ECB bond purchases, these are on their own in the market. Even greater price fluctuations can follow here. Investors looking for higher yields in government bonds will also consider US Treasuries, where 10-year paper is yielding almost 3% again.
Christian head
Head of portfolio management for pensions at Union Investment
Christian Kopf has been in charge of bond fund management at Union Investment since 2017. He is one of six members of the Union Investment Committee (UIC), which sets the guidelines for the tactical management of Union funds by the individual portfolio managers.
Union Investment is the investment company of DZ Bank and part of the cooperative financial group.
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Image sources: Union Investment
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