Over the course of a lengthy career as a funds manager, Michael Krautzberger long ago lost his belief in the theory that markets always run efficiently.
Still, the intensity of the recent, sudden sell-off of European bonds – especially German bonds – surprised the savvy head of the Euro Fixed Income Team at BlackRock, the world’s largest investment management firm. He spoke to Handelsblatt about the recent developments.
Handelsblatt: Just five weeks ago the yield, or interest, on 10-year German government bonds (known as Bunds) was approaching the zero-percent mark. Then, suddenly, it climbed sharply. What happened?
Mr. Krautzberger: Many investors took similar positions up until the end of April and were counting to a great extent on bond prices continuing to increase and yields to fall, primarily due to the European Central Bank buying up bonds. But then came reports that caused investors to change course.
What kind of reports?
First, the somewhat higher inflation data [in the euro zone] and increased inflation expectations. Second, the larger supply of new government bonds. Many countries took advantage of low interest rates to move up their issuing of bonds. In addition, no bonds matured in May, so no money was flowing back to investors. Third, economic growth in the euro zone surprisingly turned out better, coinciding with disappointing data from the United States.
That’s all well and good, but does it really justify the huge sell-off?
The reports themselves don’t justify it, but the problem is that many people were caught on the wrong foot. That is why the first sales quickly had a ripple effect and resulted in a downward spiral of the market. All of the activity is intensified by the fact that liquidity on the bond market has generally declined, so trading has become more difficult. But, I must admit, the intensity of the activity also surprised me.
Was it detrimental to your portfolios?
No, we weathered that quite well in our actively managed funds and performed better than our benchmarks. For one, because we were already a bit underweight in long-term Bunds and, for another, because we put our trust in inflation-linked bonds, which have fared better than conventional bonds.
Have you suffered any outflows from your actively managed funds?
There were even inflows with the flexible bond funds and fixed income funds for short-term securities. There were fluctuations with the conventional funds for euro-zone government bonds, but at the end of the day, nothing much happened.
Where did the money withdrawn from Bunds flow to instead?
Not all that much money was drained directly out of Bunds. A lot was channeled through the derivates market, such as the sale of short Bund Futures contracts, which allows investors to set large amounts of money in motion with little investment. That, in turn, has an impact on the prices in the cash markets, and therefore on Bunds.
The ECB since March is buying over €60 billion ($64.99 billion) per month in bonds, and recently said it was speeding up purchases in May and June. Will that stabilize the market?
I think so. The latest ECB statements about stepping up purchases already have certainly stabilized the bond market. That is why a renewed counter-movement toward declining yields is quite possible.
The ECB wants to drive up inflation in the euro zone with its purchases. Will bond prices fall further if they succeed?
In the long run, yes. If I buy a 10-year Bund today and plan to keep it for a long time, then I must more or less hope that the ECB is not successful with its purchasing program and inflation remains low. If inflation increases significantly, then market losses of 4 to 6 percent are possible over a span of two or three years if you keep a long-term Bund bond in this scenario without active management.
Isn’t it senseless then to buy or even hold Bunds, if you believe in a rising rate of inflation?
If you are expecting a quick and sharp rise in inflation, then certainly. But if you assume a medium-term stabilization, you can’t think too far ahead as an institutional investor. The market won’t take a closer look until the beginning of next year at whether or not the ECB will terminate its purchasing program in autumn 2016.
But as a funds manager, shouldn’t you act now?
It isn’t necessarily smart to position yourself against the ECB’s purchases a year and a half ahead of time and massively sell Bund bonds. Currently, we are only moderately underweight and will remain so for the time being. Tactically, we bought more duration in the recent sell-off, having put our faith in longer-running bonds.
So the ECB is the driving force in the markets?
Through its direct market intervention, of course, the ECB is a very relevant factor, and you certainly need really good reasons to stand against such a strong buyer. In this respect, the ECB’s bond buying program also naturally influences the behavior of investors.
Andrea Cünnen covers bond markets and their investors for Handelsblatt in Frankfurt. To contact the author: [email protected]