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Recession, what recession?

By Bill Thornhill
02 May 2019

Dismal European growth has weighed on rates, forcing buyers down the curve in search of yield and spread. A sharp turnaround feels distant, but a stabilisation has already materialised and investors that piled into long-dated bonds may come to regret it.

The collapse of 10 year Bund yields from 50bp to zero in the past six months has forced investors down the curve in search of a better return. Nowhere has this phenomenon been more conspicuous than in the covered bond market where the flavour of the month transmuted from the five year to the 15 year between January and April.

This was accompanied by a 25bp-30bp reduction in spreads to mid-swaps, taking the market back to the elevated levels seen in October 2018 when the situation was much more fragile. Although some bond investors have noticed that the herd is still in full bull mode.

A macro fund managed by a major Scandinavian asset manager recently switched from covered bonds to equities. And Commerzbank analysts this week described covered bonds as “the least favoured asset class” of all products assessed by the Union Investment Committee.

More fundamentally, the rates market got its first taste of things to come this week after first quarter eurozone GDP doubled to a higher than expected quarterly pace of 0.4%. Ten-year Bunds barely reacted, but some of the world’s biggest investors are getting tetchy.

Amundi said this week that rates valuations are “extremely expensive” in Europe, preferring US Treasuries to German Bunds. BlueBay Asset Management said a better global outlook would support eurozone demand and BlackRock agreed that Europe was on “the cusp of recovery”.

For the time being, the bond bulls are in charge. But if forward-looking data improves, a reassessment will quickly follow — just as it did in October 2016 when 10-year Bund yields jumped 50bp in six weeks and the positive absolute return that investors had banked on was wiped clean.

By Bill Thornhill
02 May 2019