In a nutshell
Safe government bonds remain unattractive in view of public debt and economic recovery.
Valuations for European corporate bonds call for caution. The financial sector remains the favourite one.
Emerging market bonds look promising; we favour bonds from frontier markets.
Politics continues to play a role
While uncertainty surrounding Trump's erratic tariff policy eased in the third quarter, his attacks on the Fed raised concerns about its independence. On this side of the Atlantic, French Prime Minister Bayrou's vote of confidence stirred emotions and yields. Bond markets remain political in some respects. What other factors do we consider important?
Safe government bonds remain an unattractive asset class
In August, Fed Chairman Powell signalled at the Jackson Hole conference that potential weaknesses in the US labour market could be weighted more heavily than concerns about tariff-related inflationary effects, at least in the short term. In view of this, we expect US key interest rates to fall by a further 25 basis points by the end of the year. No central bank stimulus is expected in the eurozone or the UK in the final quarter; the Bank of England is also unlikely to take action again until 2026. At the longer end of the yield curve, we see little potential for falling yields in the medium term. This is countered by the combination of rising public debt, a stable economy in the eurozone and structurally higher inflation in the US. The outlook for German government bonds and US Treasuries is correspondingly limited or even negative. In local currency terms, we expect only UK government bonds to benefit from high carry with roughly unchanged yields, although the inflation rate must still be deducted for a real assessment. We remain cautious about France, whose yields have risen to the level of Italy and Greece amid uncertainty about the status and future of fiscal reforms.
Safe government bonds: UK with the best outlook
Performance of 10-year government bonds, total effect of price/yield changes, coupon income and roll-down effect
Forecasts: base interest rates and government bond yields (in %)
Berenberg and consensus forecasts compared, figures for mid and end of 2026
Corporate bonds: spread levels call for caution
European corporate bonds continued to perform well throughout the summer. Risk premiums on euro-denominated investment-grade securities traded at levels last seen during the ECB's extensive purchases in the COVID-19 crisis. This development urges us to act more cautiously in the coming months. On the one hand, technical factors such as a seasonally high number of new issues could weigh on the market segment. On the other hand, corporate earnings are likely to deteriorate due to the effects of US tariff policy on economic data. In addition, Japan does not yet seem to have emerged from the low interest rate phase, which is likely to lead to further headwinds. Due to low domestic interest rates, Japanese investors have often invested in international bond markets. This trend could reverse as local interest rates rise. In addition, fiscal policy uncertainties in France could dampen market sentiment. Although corporate bonds are not at the forefront, they are unlikely to remain completely unaffected by these developments. By contrast, financial bonds should continue to perform well. Positive earnings momentum has continued in the most recent reporting period, justifying current valuation levels. However, given the risks, we prefer a more defensive approach here as well, focusing on Tier 2 bonds and the senior segment.
Corporate bonds: valuations urge caution
Risk premiums on Euro IG corporate bonds at levels last seen during the ECB's massive purchases in the coronavirus crisis
Emerging market bonds: frontier markets preferred
The at least partial easing of trade disputes and the prospect of interest rate cuts by the Fed amid a continuing robust US economy have recently had a positive impact on emerging market bonds. In the hard currency segment, they benefited from the constructive mood, with risk premiums falling to multi-year lows. Growing uncertainty about political influence on the Fed, rising government debt and initial signs of a weakening labour market resulted in a steepening of the US yield curve, with short- and medium-term interest rates falling and longer-term rates rising. In the emerging markets themselves, the prospect of further interest rate cuts and the search for alternatives to USD-denominated investments led to inflows into local currency bonds and corresponding declines in yields. Furthermore, the worrying increase in government debt in developed countries, combined with the US government's political attacks on universities, courts and the central bank, has led to a loss of confidence in supposedly safe government bonds. Emerging markets are perceived as more attractive overall due to their more orthodox monetary and fiscal policies. Accordingly, there is a clear divergence between the yields of developed and emerging markets. While developed countries have to pay higher risk premiums, local emerging market bonds are benefiting from falling yields (fig. below right). Against this backdrop, we are focusing in particular on local emerging market bonds from frontier markets. They not only offer solid fundamentals and attractive interest rates, but are also likely to benefit from the expected further decline in yields – as inflation has largely been overcome and their economies are already cooling down as a result of tariffs.
EM bonds sought after over developed countries
While yields on government bonds from developed countries are rising, those on emerging market securities are on the decline
Conclusion: opportunities in finance and frontier markets
Government bonds remain the least attractive segment among the bond sectors we cover. European corporate bonds are more interesting, although we are increasingly cautious given the low risk premiums. By contrast, we take a much more positive view of the financial bond sub-segment, particularly senior and Tier 2 bonds. In emerging and frontier markets, we continue to favour bonds denominated in local currencies, which offer further potential given low inflation, among other factors.
Authors
Martin Mayer
Martin Mayer, CEFA, has been working as a portfolio manager since 1998. Since November 2009, as Senior Portfolio Manager at Berenberg, he has been responsible for the pension strategy of private asset management and for individual special mandates. After completing his training in business administration (Wirtschaftsakademie) and his degree in economics (University of Hamburg), he joined Deutsche Bank's asset management department in 1998. Until 2008, he managed individual client portfolios for Private Wealth Management and completed further training as a CEFA investment analyst/DVFA in 2001/2002. Mayer joined HSH Nordbank in the summer of 2008 as Deputy Head of Portfolio Management.
Felix Stern
Felix Stern joined Berenberg Asset Management more than 25 years ago as a fixed income portfolio manager. Today, the Senior Portfolio Manager heads the Fixed Income Euro Balanced team and is responsible for the selection of defensive bonds from the investment grade segment as well as specializing in short-dated bond concepts. He is also the main portfolio manager responsible for several Berenberg mutual funds. After several years in the market research department of British American Tobacco (Germany) GmbH, the trained industrial clerk switched to fixed income portfolio management at the beginning of 2000. The graduate in business administration completed his studies part-time at the distance learning university in Hagen and also obtained a degree as CCrA - Certified Credit Analyst (DFVA) as well as CESGA – Certified ESG Analyst (DVFA).
Sebastian Burbank
Sebastian Burbank has been with the company since October 2024. Before joining Berenberg, he worked for 3 years at Deka Investment as a portfolio manager for global bonds and currencies. He focused in particular on local and hard currency bonds in the emerging markets. He holds a Master's degree in Finance from Goethe University in Frankfurt am Main and a Bachelor's degree in Economics from the University of Essen.