Horizon Q2│2023 - Bonds

Positive outlook in all segments

Prof Dr Bernd Meyer and team provide an outlook for the 2nd quarter of 2023 in the current Horizon publication.

In a nutshell

  • Safe government bonds offer attractive yields, but are not quite as interesting as other segments.

  • European corporate bonds remain in demand at high interest rates; we prefer the financial sector.

  • Emerging market bonds are back in vogue, local currencies with the best risk-reward ratio.

Constructive start to the year is not a flash in the pan

“Interest rates are back”, we wrote in the last issue of “Horizon”, and the first weeks of the year brought rising demand for fixed-income securities in many segments. Adequate yields and interesting coupons again provide for continued attractiveness despite temporary setbacks. We expect positive returns from bonds in the coming months.

Government bonds provide yields again; the US remains in the lead

As expected, the losses of the previous year in the safe government bond segment did not continue during the first quarter. Although the recovery that started at the beginning of the year initially slowed down from the end of January, and yields subsequently climbed above the levels they were at the turn of the year, the trend reversed again. Going forward, current yields should be the main source of return, with the fact that inflation in the US is on the retreat earlier than in the Eurozone playing a role. In addition to an easing in long-dated bonds, this also leads to a divergence in central-bank policies. The US Fed and the Bank of England should begin to lower their key interest rates again in the second half of the year after further hikes in the second quarter, but the European Central Bank will not. In the Eurozone, we expect a total increase in the main refinancing rate to 4% by the summer, without a turnaround in the following months. Overall, the segment has clearly gained in attractiveness and adequate current yields are again being offered in all three currency regions.

Safe government bonds should selectively make money again

Past and expected performance of 10-year government bonds, overall effect from yield/price change, coupon income, and roll-down effect

Time period: 16/03/2018–16/03/2023.
Source: Bloomberg, own calculations, iBoxx Government Bond Indices (7–10 years, TR).

Forecasts: base interest rates and government bond yields (in %)

Berenberg and consensus forecast in comparison, values at year-end 2023 and mid-year 2024

* Average, consensus as of 16/03/2023.
Source: Bloomberg.

Welcome back - demand for corporate bonds is rising

European corporate bonds in the investment-grade segment have held up well since the beginning of the year. The attractive risk premiums and the increased yield level attracted investors. This led to a slight decline in risk premiums. Even though the valuation now appears somewhat less attractive and the potential for a further narrowing of spreads is limited, we maintain our overall positive view. At over 4%, corporate bond yields are at their highest level in more than a decade. In addition, it is evident that yield-oriented investors, who have shifted to alternatives in the negative interest rate environment, are again showing interest in European corporate bonds, thus strengthening demand. This is partly met by the well-filled new issue pipeline, and we also continue to favour new issues as they offer a yield premium over outstanding bonds. Moreover, their coupon is at current market levels, which strengthens the generation of current income after years of very low coupons (see figure below left). Within corporate bonds, we prefer the financial sector. The balance sheet quality of European banks has improved significantly in recent years. In addition to a significantly higher equity base, this is also reflected in the decline in the share of non-performing loans, as recently confirmed by aggregate data from the European Banking Authority. Compared with corporate bonds, the yields of financial securities are also higher and the maturity risks lower.

Euro corporate bonds: coupons are finally attractive again

After previously meagre years, coupons on new issues at current levels are again helping to support decent returns for investors.

Time period: 31/12/2017-28/02/2023.
Source: Bloomberg, own calculations; rating universe: investment grade.

Emerging-market bonds: local-currency advantage

Emerging-market bonds were in a state of flux in the first quarter. While the start of the year was still promising and all three segments, ie both government and corporate bonds in hard currencies as well as local-currency bonds, were flushed upwards as part of a general liquidity rally, a reversal set in at the beginning of February after the strong US labour market data with rising US yields and a strengthening US dollar. The fact that the market performance proved to be very homogeneous across all asset segments, not only in the upward but also in the downward movement, shows that general risk sentiment was the dominant force for performance or that the market was driven by the movement of US yields and the US dollar, while individual country, sector or currency risks took a back seat. We expect this to change in the second half of the year at the latest, and the market to become more heterogeneous. In this case, we expect performance advantages in the local-currency segment. Compared with the hard-currency segment, the strongly increased local yields already offer an attractive current interest rate (“carry”) with a lower duration. If the rate hike cycles in the emerging markets end earlier than in the US and Europe, price performance will gain in importance again in addition to carry. Thus, in the course of the year, a gradual increase in duration in the market for local currency bonds seems opportune to us in order to participate in this development.

EM unusually homogeneous, local-currency bonds ahead

So far, 2023 stands out due to high homogeneity between hard and local cur-rency (HC, LC); this will change in the second half of the year at the latest.

Time period: 31/12/2021-13/12/2022, indexed to 100 as of 31/12/2021.
Source: Bloomberg, EM = Emerging Markets.

Conclusion: opportunities in all segments

After the “return of interest rates”, we see opportunities in all three bond segments discussed here. Safe government bonds again offer interesting current interest rates, but the European corporate sector is even more attractive. Here we prefer the financial sector, and we also participate in new issues with yield premiums and adequate coupons. Finally, emerging markets will develop more heterogeneously over the course of the year than they have recently, which should benefit local currency bonds in particular. The latter and corporate bonds remain our favourites.


Martin Mayer
Senior Portfolio Manager Multi Asset
Felix Stern
Head of Fixed Income Euro Balanced