The aim of Donald Trump’s administration is disruption – also regarding geopolitics. The bond market is currently reflecting potential uncertainties. Find out what this means for investors. By Lars Conrad
The bond market is perhaps the best indicator of geopolitical upheaval. This has been evident in recent days when Donald Trump first humiliated and then snubbed Ukrainian President Volodymyr Zelensky in front of the international press. Fears of a break with the past are spreading. The ‘free West’, held together by the world’s military power, the United States, might just be on the verge of collapse.
Europe reacted swiftly. Ursula von der Leyen, President of the European Commission, proposed a loan of EUR 150 billion and easier credit conditions for EU countries. Over a period of four years, EUR 650 billion should be activated for defence spending.
Europe’s largest economy has also reached a turning point. Germany’s prospective new government wants to lift the ‘debt brake’, a constitutional mechanism that limits the annual net borrowing of the (relatively) low-debt country to 0.35 per cent of gross domestic product. After the brake has been lifted, forthcoming armaments expenditure and an infrastructure package worth around EUR 500 billion are to be financed by credit over the next few years.
The markets reacted quickly. German Bund yields, traditionally one of the safe havens in the bond market, soared. Ten-year Bunds rose by more than 30 basis points the following day. This was the sharpest change since the reunification of Germany in 1990.
In addition, the yield curve, which reflects the yields of German Bunds with different maturities, steepened noticeably. Long-term bonds are yielding more than short-term bonds, which ultimately also points to growing uncertainty. Yields on short-term bonds are traditionally more influenced by the central bank’s current policy, while possible uncertainties (e.g. regarding a larger supply of government bonds) tend to be reflected in long-term bonds.
The market reaction was even more impressive from an international perspective. While yields on German Bunds rose, they fell for US Treasuries. The ‘US Treasury-Bund spread’, which reflects the difference in yields between the two government bonds, has fallen by around 70 basis points in recent weeks (for a term of 10 years). At around 150 basis points, the spread was thus as low as it was last seen in September last year. In addition to the developments in Germany, growth and inflation concerns in the wake of the Trump administration’s excessive tariff policy were also drivers of this development.
Active management is crucial in turbulent times. This is particularly true in the bond market, where opportunities always arise. So how are portfolio managers responding to current developments?
First of all, there have been no major reallocations in our pure bond portfolios, which ultimately also speaks in favour of the portfolio managers. They have taken a more cautious and globally diversified stance.
In any case, the occasional significant movements described above may be a little exaggerated. At least that is what a look at the details of the implementation of the debt brake exit suggests. The package still has to be approved by a two-thirds majority in the current Bundestag, which requires votes from the opposition. If this happens as planned, a significant number of the measures will only come into force after a delay. It will take some time for the construction measures and the implementation of defence contracts to be reflected in an increase in the supply of German Bunds.
Nevertheless, we have recently (slightly) reduced the duration in our portfolios. We also see opportunities in selective corporate bonds with top credit ratings, where yields have risen. It also seems questionable whether the lower spreads of some other government bonds compared to German Bunds are sustainable. Or whether we are witnessing a speculative exaggeration that may not last.
Lars Conrad is Director Fixed Income at Flossbach von Storch SE.