In a nutshell
Safe government bonds burdened by interest rate volatility, upward potential only to be expected in the event of economic weakness.
The financial sector remains the favourite for European corporate bonds, while the real estate sector is coming into focus.
In emerging markets, we consider local currency bonds to be particularly promising.
Opportunities and risks in uncertain times
In the second quarter, Trump’s tariff and tax policy caused strong fluctuations on the bond markets. The global impact on the economy, inflation, exchange rates and public finances will continue – this opens up risks, but also offers opportunities. Where do we see these and what else should be considered?
Bleak prospects for safe government bonds
As we expected, the rise of US Treasuries in the first three months of the year did not continue. Instead, safe govern-ment bonds from Europe led the way in the second quarter – German government bonds and British gilts rose. In an environment of increasing fears of rising government debt, Moody’s followed suit as the last of the three major rating agencies and downgraded the US’s credit rating to only the second-highest level. German government bonds, on the other hand, were sought after as a safety anchor in the wake of the market turbulence caused by US tariff policy. They also benefited from a fall in the inflation rate to just 2.1% year-on-year in May and two interest rate cuts by the ECB of 25bp each in April and June. However, the potential is likely to be exhausted – as with the US Fed, we do not expect any (further) interest rate cuts from the ECB until next year (bottom right). In view of the increased variability of macro data due to economic and trade policy factors, the volatility of safe government bonds should also remain high without yields on longer maturities falling permanently. Against this backdrop, government bonds with high and top credit ratings will lack attractive earning prospects in both nominal and real terms for the foreseeable future.
Safe government bonds: potential low to exhausted
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 the end of 2025 and mid-2026
European corporate bonds: focus on carry
The further development of European corporate bonds will largely depend on whether the US and Europe run into economic difficulties and whether this leads to a reassessment of credit risks. There are currently no signs of economic concerns in the risk premiums. Valuations in the investment-grade segment can still be described as fair, whereas the high-yield segment appears rather expensive. However, since the end of the negative interest rate phase, many investors are increasingly focusing on the yield level rather than the risk premium. While yields of 3.2% can be achieved with investment-grade bonds, the figure for high-yield bonds is 5.2%. With regard to the key financial figures of the companies, there are still no signs of any impairment and we are taking advantage of the opportunity to collect a higher current interest rate (“carry”) on corporate securities compared to more defensive segments. However, in light of the increased economic uncertainty, we are taking a selective approach and prefer financial bonds to corporate bonds. The latest quarterly figures for the financial sector were once again solid, and the US tariff policy should only have a minor impact on balance sheets. We also increasingly like issuers from the real estate sector. Their key financial figures have stabilised and they should benefit from the initial appreciation of real estate prices. The sector should receive additional tailwind from lower refinancing costs.
Corporate bonds: banks increasingly better positioned
In the European banking sector, the total capital ratio has risen significantly, while the quality of credit books has improved
Emerging market bonds: local currencies preferred
After the market turbulence following the tariff announcements on “liberation day” at the beginning of April, US President Trump was forced to backtrack and grant a 90-day pause for negotiations. This has since led to a recovery in risk assets, which has also benefited emerging market bonds. Their risk premiums have now returned to the previously low level. In the preceding period of uncertainty, there was a significant decline in both the price of US government bonds and the US dollar – contrary to the typical flight to supposedly “safe havens”. This synchronous weakness was triggered by position adjustments, growing uncertainty about political influence on the US Federal Reserve and rumours of foreign central banks selling their holdings. Among emerging market bonds, the local currency segment benefited in particular. Yields fell further here in April, while US yields rose sharply. Historically, central banks in emerging markets have often waited for a signal from the US Fed before making interest rate decisions, which can be particularly critical in the case of interest rate cuts: if the central banks had cut their key interest rate first, this would have led to capital outflows and devaluation pressure on the respective currency. On the other hand, the recent combination of currency appreciation and yield declines not only shows increased investor confidence in emerging markets, but also gives local central banks the necessary flexibility to cut their key interest rates independently and in line with their economic development. Against this backdrop, we prefer the local currency segment not only because of its attractive interest rates, but also because we expect further declines in yields as inflation has already been overcome and the economy is beginning to cool as a result of tariffs.
EM countries: flows into local currency securities continue
In contrast to US bonds, the falling yields on local currency securities in recent weeks indicate increasing capital flows
Conclusion: interest rates only attractive beyond the government segment
Safe government bonds do not offer any interesting income prospects, especially not when inflation is taken into account. At best, they are suitable as a safety net for temporary risk-off phases. In contrast, we still see adequate interest rates for corporate bonds, preferably in the financial sector, where solid key figures go hand in hand with lower refinancing costs. Emerging market securities in local currency could benefit from falling yields and, from a euro perspective, from currency effects. They are also interesting from an interest rate perspective.
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).
Wei Lon Sung
Wei Lon Sung has worked in fixed income portfolio management at Deka Investment since 2018, with a focus on emerging markets. He joined Berenberg in 2023 and contributes his expertise in the fundamental selection of emerging market bonds in local and hard currencies. He holds a Bachelor and Master of Science in Mathematics from Goethe University Frankfurt.