Key eurozone and global government bond ETFs have been losing ground since Germany’s incoming government announced a historic boost in spending that has triggered a spike in sovereign bond yields.
The Xtrackers II Eurozone Government Bond UCITS ETF 1C (XGLE) lost 2.9% this week, while Vanguard’s EUR Eurozone Government Bond UCITS ETF (VETY) is down 1.6%.
Yields on German government bonds have continued climbing after Wednesday’s sharp spike. Yields on French and Italian debt also rose, and the spread between Italy’s 10-year bonds over Germany’s is now hovering around 100 basis points, its lowest since September 2021. Japan’s 10-year borrowing costs also hit a 16-year high on Thursday, at 1.52%, and yields on the US 10-year Treasury touched 4.32%.
“The events in Germany were the most significant on the fiscal front in 40 years, but the selloff has been the sharpest in the period too. There’s a limit as to how high bund yields can go before some market participants find yields attractive,” TwentyFour AM portfolio manager Felipe Villarroel says.
“In portfolios where the bund allocations were larger and longer, we have trimmed 10Y and 30Y bunds but not sold all of them.”
How Fund Managers Are Reacting
“This is a duration sell off in the EUR curve. So longer duration assets have felt the most pain,” Villarroel continues. “We have shortened our duration in EUR assets by selling some bunds. We have added small amounts of EUR credit. This is a significant event for rates but also for spreads. There’s reason to believe that potential growth in Europe might be higher in the future which means spreads could be tighter, all else equal.”
Antonio Serpico, senior portfolio manager at Neuberger Berman thinks that this movement, which has seen a simultaneous widening of benchmark rates and compression of spreads, brings out the relative value of government debt vs. credit. “We have begun to rotate portfolios in this direction”, he says. “We have also begun to gradually add duration into portfolios given that, on the one hand, the announcement of the defense spending plan will have to be effectively implemented, and, on the other hand, we are living in a context laden with uncertainty for economic growth, which could suffer further slowdowns from the tariff wars”.
Howard Woodward, co-portfolio manager of T. Rowe Price’s Euro Corporate Bond strategy, sees signs of stability amid the selloff. “Despite this significant movement in sovereign markets, European corporate bond spreads remained stable, indicating good resilience in the investment grade segment,” he says.
A Stronger European Economy?
Investors around the world demand more to buy debt following the nation’s historic spending plans, even though this arguably reflects an improving outlook for Germany’s economy rather than concerns on the sustainability of its debt. Berlin has one of the lowest debt/GDP ratios in Europe at just 63%.
Goldman Sachs’ economics research team upgraded their German growth forecast materially, even assuming that spending will be scaled up gradually. “We raise our growth forecast by 0.2pp to 0.2% in 2025, by 0.5pp to 1.5% in 2026 and by 0.6pp to 2% in 2027 relative to our recently upgraded baseline”, they say in their latest paper released on March 5.
Moreover, the fiscal news lowers the pressure for the ECB to reduce rates below neutral. Goldman Sachs no longer expects the Governing Council to cut at the July meeting and raises its forecast for the terminal rate to 2% in June. It had previously forecast 1.75% in July.
What’s Next for Bonds
“Overall, we expect markets to continue to price in some increase in supply and potentially an increase in the inflation premium”, says Annalisa Piazza, Fixed Income Research Analyst at MFS Investment Management. “Steeper curves and some stabilization of yields at current levels are the most likely scenario for now,” she adds.
”Obviously, fiscal changes are only one of the factors that move markets nowadays. The balance of risks that will come from fiscal support and the potential tariffs coming from the US from April will help to calibrate market pricing.”
According to Neuberger Berman’s Serpico, “the European rate market now has to deal with expectations of an abundance of government debt and therefore has to move to a higher yield range than in the recent past. At the same time, though, we believe that in the medium-term European rates should reflect the fundamentals of the economy, which include weak growth and declining inflation.”
While volatility is extremely high, a lot has been priced in over the last couple of days, TwentyFour’s Felipe Villarroel finds. “We would expect bunds to find some support in the 2.9%-3% area. Bunds hedged back to dollars are now amongst the highest yielding developed government bond markets in the world.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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