Growing signs of a sell-off in the perceived safe haven of German government bonds are creating a “potentially poisonous cocktail” in the asset class, experts have warned.
The yield from 10-year German bonds, known as bunds, is 0.07 per cent – a level far lower than the 1.53 per cent yield just a year ago and thus prices are much higher.
While some fixed income investors believe the rally could continue and drive the bonds to a negative yield, they have raised the alarm about the growing signs of a sell-off on the horizon.
David Roberts, head of fixed income at Kames Capital, said: “German bunds face a potentially poisonous cocktail of resurgent inflation and wage increases, which could hit home later this year.”
Government bond prices are primarily influenced by the country’s base interest rate and inflation expectations, so a rise in inflation could result in a decline in bond prices.
However, with the eurozone in a deflationary period brought on by the fall in the price of oil, and the European Central Bank (ECB) buying up huge quantities of government debt, Mr Roberts said “yields on German bunds could decline further towards zero in the near term”.
But he added: “If you look at bunds in anything other than the shortest possible timescale, the risk becomes very clear.
“The bonds are potentially poisonous on a six-month view, for example, once near-term deflationary pressures subside.”
Chris Iggo, chief investment officer for fixed income at Axa Investment Managers, agreed that “10-year bunds are likely to have a negative yield pretty soon”. But he said: “I’m already very uncomfortable with the valuations in fixed income markets. But this would make things even worse as sourcing income from bonds – what they are supposed to be all about – will be nigh on impossible.
“For the bond business, this means the only realistic source of flows will be into higher beta assets (high yield) and strategies (unconstrained, flexible funds) to be followed by a painful period of negative returns when we get the eventual repricing.”
While analysis shows bunds to be extremely poor value on a long-term horizon, TwentyFour’s Mark Holman has warned investors not to underestimate the power of the ECB’s bond-buying programme, which is pumping €60bn (£43bn) into eurozone assets every month.
Mr Holman, who is chief executive at the fixed income boutique, said 10-year bunds could “easily” yield less than zero and said “in the short term they are well anchored and remain a good risk-off asset”.
He said: “Longer term the odds are stacked against the investor in long-dated bunds.
“However, before we get to the long term, we have to pass through the short and medium terms, which could be painful for those shorting bunds.”
Will bunds provide a safe-haven, or is a sell-off looming?
The issue of low or even negative bond yields is not one confined solely to German government bonds, known as bunds.
The deflationary environment and the European Central Bank’s bond-buying programme, instituted by president Mario Draghi, has led to negative bond yields on the short-term, two-year debt of all the large eurozone nations.
Estimates put the percentage of eurozone bonds offering a negative yield at 25 per cent and the total at around €1.5trn (£1.1bn).
Earlier this month, the Swiss central bank issued 10-year debt with a negative yield of -0.055 per cent. For the first time in history, investors were effectively paying a government to lend it money for 10 years. Investors still lapped up the bonds, though, buying €222.4m of them.
