Bond fund managers have been forced to respond to this abrupt change in market conditions at a time of wider market volatility because of trade conflict and talks over the future of Ukraine.
Yields on 10-year German Bunds, the benchmark security for the eurozone, are at 2.79%, a rise of 43 basis points from a month ago.
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. This gap or spread between is seen as an indicator for risk in the eurozone because German bonds are considered the lowest risk in the currency bloc.
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%.
How Bond ETFs Have Responded to the Spike in Yields
Key eurozone and global government bond ETFs have been losing ground as a result – bond yields move in different directions to prices, so the sale of bonds has triggered a price fall and a rise in yields and that has impacted ETF returns directly.
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%.
“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 10 year and 30 year Bunds but not sold all of them.”
UK Gilts Also Rising
UK government bond yields have also been pushed up this week. The longer end of the yield curve has been most affected, with 10-year yields rising 21 basis points in a month to 4.69% and the 30-year yield gaining 19 basis points to 5.25%.
Over a year these maturities have gained 69 basis points and 85 basis points respectively at a time when interest rates and inflation have fallen, continuing a trend that started at the beginning of 2025. These yields are significantly higher than the eurozone because UK interest rates are 4.5% after just three rate cuts, compared to 2.5% on the continent. Domestic concerns about the new UK government’s debt and spending plans have supported yields, as well as market expectations of a slower pace of rate cuts as inflation picks up again in the UK.
Mark Dowding, CIO at RBC BlueBay Asset Management, said in a note: “RBC BlueBay continues to be concerned at the inflationary backdrop and the lack of fiscal space in the UK. As gilt yields are dragged higher by und yields, the risk is that higher funding costs feed back into projections around UK debt.”
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.”
Duration is a key metric for bonds and measures the sensitivity of debt to interest rates; the longer the bond maturity, the more likely interest rates will impact on yields and prices.
In this case, longer maturity bonds, those from 10 years and beyond, have borne the brunt of the recent selloff, pushing up yields at the longer end of the yield curve.
Antonio Serpico, senior portfolio manager at Neuberger Berman thinks that this movement brings out the relative value of government debt against credit, or corporate bonds.
“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 [the gap between investment grade and non-investment grade bonds] 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 0.2 percentage points to 0.2% in 2025, by 0.5 percentage points 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.
Yield curves reflect the different cost of debt for bonds across different maturities.
”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.”
Neuberger Berman’s Serpico says: “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 says. “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.”
Additional reporting by James Gard
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
