The world economy is marked by sluggish growth and absent price pressure. Despite unprecedented monetary easing, inflation expectations have declined further. Bond yields have set new historical lows and can continue to do so. Central bank buying programs add to the picture as bond scarcity in core government markets increases downward pressure on interest rates.
In the Eurozone, the rules of the ECB’s Quantitative Easing (QE) program are forcing the ECB to buy long-end bonds only. The deposit rate rule only allows the ECB to buy bonds with a yield to maturity higher than the deposit rate, i.e. minus 0,4%. With declining interest rates, more and more bonds trade below the deposit rate, making them ineligible for the ECB to purchase.
In practice it means that since the start of June, the minimum maturity that can be bought moved from 5 to 8 years in Germany. This also has a second round effect: with a decreasing pool of purchasable bonds more needs to be bought per bond to get to the required monthly target of EUR 80 billion. As a result, one of the other rules of the program becomes increasingly pressing: the maximum percentage that may be purchased per outstanding bond. This limit, also known as the issue limit, is set at 33%.
Without changes in the parameters of the purchase programs, we think that the ECB will struggle to buy government bonds in both Germany and the Netherlands around year end. The ECB has options to increase the issue limit for bonds issued before 2013 to e.g. 50% or more. This will give the ECB leeway to continue buying for one or two more quarters. And since these older bonds are mostly concentrated in the long end of the curve, the ECB will again focus buying in that part of the curve.
An alternative ‘nuclear’ option to address the scarcity issue is for the ECB to give up on the capital key rule. Currently the government bond purchases are split across the Eurozone countries according to the capital key weights. The key is calculated according to the size of a member state in relation to the European Union as a whole, size being measured by population and gross domestic product in equal parts. Changing the purchasing basket according to e.g. debt outstanding (market capitalization) would hugely favor Italian bonds at the expense of German bonds. Italy’s outstanding public debt is higher in nominal terms whereas the economy is smaller. We regard this option as politically highly controversial for now. It would be a step closer to Eurobonds. However, in the context of an existential threat to the euro system (Brexit, meltdown Italian banking sector) nothing can be excluded.
As prospects for (further) rate cuts in the US and the Eurozone are slim, long dated bonds remain our favorite. In the US the 30-year yield is approaching the 2% handle. The US money market curve no longer discounts any rate hike for the next two years. From a risk/reward perspective, most value is in long dated US Treasuries. In the Eurozone we expect the 30-year segment in Germany to benefit from further ECB policy measures, as explained above.
The surprise outcome of the Brexit referendum is bullish for UK Gilts. Business and consumer confidence in the UK will tumble. The Bank of England may potentially restart Quantitative Easing. The UK Gilt market will converge to the Eurozone bond market dynamics, having shown more parallels with the US Treasury market in recent years.
As the credit cycle is maturing, leverage is rising, especially for US companies. This calls for a cautious stance. We favor the European corporate bond market, more specifically subordinate financials. Brexit fears and worries about the Italian banking sector have pressured this segment year to date. We believe current valuations offer enough protection. The ECB corporate bond purchasing program will have positive spill-over effects also for this specific sector.
The star performer of the year has further to go. The imminent threat of a Fed rate hike has disappeared for now. This enables investors to focus more on the attractive yield differential compared with developed markets. Fund flow information underlines that appetite for this battered sector is gradually coming back.
This report is not available for users from countries where the offering of foreign financial services is not permitted, such as US Persons.
Your details are not shared with third parties. This information is exclusively intended for professional investors. All requests are checked.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.