Bond investors face a conundrum over Europe’s safest asset

The rally in German bonds previously week has reminded fund managers why betting towards Europe’s most secure belongings is a dangerous enterprise.

The debt slid final month as economies confirmed indicators of recovering from the ravages of the coronavirus epidemic, main some analysts to foretell yields would quickly flip positive after a yr under zero. Instead, worries over a second wave led traders to dump shares and switch to havens corresponding to bunds.

Now, funds are in a quandary. An financial restoration, elevated German borrowing and regional stimulus are all components that recommend greater bund yields down the highway. But these shorting bunds previously have been badly burned, and for some, German debt simply isn’t value touching.

“We have no position in bunds,” stated Patrick Armstrong, chief funding officer at Plurimi Wealth LLP. “Don’t see the attraction of owning negative 0.3%, but not a good level to short.”

While the unfavourable yields imply traders lose money if holding the debt to maturity, merchants can generate profits if it retains rallying. That has led German bonds to return greater than 7% because the begin of 2018, via the turmoil in Italian politics and Brexit, commerce wars and the pandemic, in accordance with Bloomberg Barclays indices.

They function a proxy for European danger, and have a tendency to rise on issues in regards to the stability of the euro space. So the massive European Central Bank asset purchases and a plan to collectively challenge euro debt gives stability and a brand new challenger, one thing cash managers haven’t needed to cope with earlier than.

“Investors could substitute for bunds with the new European Commission issuance,” stated Ross Hutchison, an funding director in Aberdeen Standard Investments’ fixed-income staff. “We think central bank support will keep yields low, but we don’t think bunds are an attractive place to hold these overweights right now.”

Still, with the danger of a second virus wave and central banks vowing to do no matter it takes, traders are grabbing longer maturity returns wherever they will. Demand for European sovereign debt gross sales by way of banks final week topped $300 billion.

Germany initially pulled in additional than $50 billion of bids for its sale of 30-year bonds, the one tenor providing positive yields, permitting it to chop pricing on the deal.

“What makes bunds unique amongst other defensive assets is that they offer investors downside protection specifically against a break-up of the euro area,” stated Wolfgang Bauer, a fund supervisor at M&G Plc. While demand for such a break-up hedge has been diminished, he “wouldn’t write bunds off just yet.”

Lurking Risks

The bloc’s groundbreaking issuance plan isn’t confirmed but. There are indicators northern European nations might revolt, with Austria the most recent nation to declare its opposition, not eager to be on the hook for rebuilding badly-hit southern international locations.

All types of supportive world dangers are lurking. The possibilities of a no-deal Brexit this yr, the resumption of US-China pressure and the US election, to call just a few.

That may very well be good for Mark Dowding, chief funding officer at BlueBay Asset Management, who’s including publicity to bunds as a result of he expects the ECB to carry yields down. But even he’s not feeling significantly enthusiastic.

“To be honest we have no strong conviction,” he stated. “Ultimately we think yields aren’t really going anywhere.”