Rising risks End of the Bond Boom

According to Björn Jesch and Francesco Garzarelli, the golden years for bonds are over. But both experts predict that differences in the approach of European and American central banks will influence to what degree inflation or yields increase.
Bond experts Björn Jesch (left) and Francesco Garzarelli will be watching upcoming European elections very closely. Photo: Bert Bostelmann/Bildfolio

The last three decades of bonds’ bull markets are over, according to experts from Goldman Sachs and Union Investment. But it’s not all bad news.

Björn Jesch, head of fund management at Union Investment, reads Goldman Sachs analyses regularly. But he met Francesco Garzarelli, head of economic research at the American finance company, for the first time in conversation with Handelsblatt. Perhaps unsurprisingly, the two experts agreed on many points, particularly in relation to bonds.

When bond prices collapsed following Donald Trump’s election, some were already declaring the end of constant growth. Now, months later, both Mr. Garzarelli and Björn Jesch say the boom days are indeed over. But the sky is not falling.


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“The end of the bull market does not mean that we now get a sell-off on the bond markets with rapidly falling prices and rising yields,” Mr. Garzarelli said.

And, as Mr. Jesch added, it’s important to observe the differences between the United States and the European Union. “In the United States, we do indeed have an interest rate turnaround with the Fed. In the euro area, on the other hand, the ECB will keep rates low for a long time. I do not believe that we are now entering a phase of sharply rising inflation and significantly rising returns. But the fact is that the risks on the bond markets have risen and are greater than in the past few years.”

Both experts foresee rising returns in the bond market.

Mr. Garzarelli says Goldman Sachs expects 10-year federal bonds increase of 0.6 to 0.8 percent by the end of the year, with 2.75 to 3 percent for 10-year U.S. bonds.

“We view this similarly and expect 0.8 percent and 2.8 percent,” Mr. Jesch said of Union Investment. “For investors who are already in the market, however, even moderately rising returns are not good, as they mean falling prices.”

This is why Union Investment advises against government bonds in the euro zone and the United States.

“They are only suitable in a broad portfolio to compensate for possible shocks – for example when stocks and commodities markets take a nosedive, which we are not expecting,” Mr. Jesch added.

“We also forecast investors with U.S. and German government bonds to lose over one year," explained Mr. Garzarelli. “German bonds in particular are vulnerable because they offer almost no interest coupons, which would at least somewhat cushion losses.”

While fixed-income investors who are typically drawn to low-risk bond investments might see this volatility in a negative light, Mr. Garzarelli said it’s not necessarily bad thing – that is, if investors  consider the bigger picture.

“Here in Germany they’ll pop open the champagne if the yields finally rise and there is more inflation again,” he emphasized. “The ECB could pat themselves on the back, banks would be earning more, insurers could better meet their liabilities and investors would get a little more interest."

Still, he added, bond returns would not truly be attractive for first-time investors in the short term. “Because if yields rise too quickly, they slow the economy too much. Only a slow rise in yields is good for the economy. And that goes for the bottom line for anyone who manages a diversified portfolio.”

For Mr. Jesch, making money with bonds is still possible, but it’s not going to be a walk in the park. “We see opportunities for bonds from companies with good credit ratings. The interest coupons are also sometimes very low there, but the bonds still offer risk premiums when compared with government securities,” he said. “There are also interesting bonds in the emerging markets. It’s not enough, however, to simply buy an index – you have to select specifically, especially when it comes to companies.”

Mr. Garzarelli agreed: “In emerging markets, for example, we like companies that export commodities,” he said. “European corporate bonds appeal to us because they are almost sponsored by the ECB through purchases.”

By the end of 2017, however, Mr. Garzarelli predicts that there are likely to be discussions about the end of the ECB's bond purchases.

According to Mr. Jesch, declining purchases present risks for bonds, the biggest of which is the unexpected. “What happens if Donald Trump's infrastructure spending does not boost the U.S. economy? What happens if Mr. Trump breaks with China? What happens when the Brexit negotiations begin? What if Marine Le Pen wins the presidential elections in France and France turns its back on the euro?” he asked. “There is the potential for a big headwind for the markets this year.”

The fact that many investors are similarly positioned will make it difficult to redirect portfolios in the case of unexpected shocks, Mr. Garzarelli said. “This can amplify distortions."

Both financial experts said it was unlikely that Marine Le Pen could carry the election in France, though Mr. Jesch added that any election prognosis post-Brexit and President Trump has to be taken with a grain of salt.

Mr. Garzarelli added, “A win for Ms. Le Pen seems unlikely, but we just do not know. In any case, the markets have not priced in an election victory from Le Pen; the risk premiums for French and German government bonds are too low for that. But I also wonder: Would a win for Le Pen strengthen Germany's AfD?”

Not necessarily, replied Mr. Jesch, who sees the German right-wing populist party less reliant on French success.

“There were times – such as the climax of the Greek crisis – when skepticism toward Europe and the euro was much more pronounced in Germany,” he said. “How the AfD performs now depends much more on how the ruling government deals with the issues of refugees and domestic security. If the German government succeeds in curbing the fears in some parts of the population, a victory by Ms. Le Pen would be less frightening. If not, we’ll have big problems.”


Andrea Cünnen works at Handelsblatt’s finance desk in Frankfurt, reporting on bond markets. To contact the author: [email protected]