Why bonds under siege (but now becoming attractive in Europe)

The performance of the stock markets, which do not seem to care about the risks associated with the Gulf crisis, and on the contrary are in many cases moving back to historical or long-term highs, is certainly not the only paradox of the present moment. The second apparent anomaly is to be found in the bond world in the midst of an identity crisis, and it is just as significant, especially when compared with the euphoria surrounding the stock markets, so much so as to configure what analysts are calling a real 'correlation shock'.

Indeed, few would have expected in response to the geopolitical events characterising the last month and a half a substantial hold in equities after the inevitable initial lurch, but also a marked deterioration in bonds, from which one would have expected a stabilising role within an investment portfolio. Looking at US Treasuries, for example, there was an average rise in yields of more than 50 points during March, with movements first concentrated on the short end of the curve and then extended to the 10-year segments: a trend that immediately brings to mind the recent case of 2022, the unforgettable annus horribilis for fixed income.

The misalignment between asset classes is evident: on the one hand, equities are behaving as if the downturn brought about by events in the Middle East were temporary and are supported by solid corporate earnings, which reflect a still robust economic expansion despite the difficult context; on the other hand, bonds seem to be suffering far more serious and lasting consequences on growth and, above all, inflation. This divergence "raises questions about the market's correct reading of the macro-financial cycle" in the opinion of Andrea Delitala, Head of Multi Asset Euro at Pictet Asset Management, who is convinced that bonds are "excessively penalised".

The thesis is based here mainly on an analysis of the trend in real rates, i.e. corrected for expected inflation. These are currently firmly above neutral levels, which Pictet estimates at around 0% for the eurozone and 1% for the US. On the 10-year maturity, for example, the real swap rate in dollars is currently 1.3%, while in Europe it is around 0.6%, twice as far from the respective neutral rate, when if anything the economy most exposed to recessionary risks is that of the Old Continent.

The upward turn after years in which sovereign rates had plummeted to extremely low values consistent with the phenomenon of 'financial repression' occurred just over a year ago, coinciding with Donald Trump's proclamation of US tariffs and also the massive fiscal stimulus plans announced in response by the German government. There has been no turning back since then, and such levels are, however, difficult to explain by macroeconomic fundamentals, 'since they suggest,' according to Delitala, 'the presence of a risk premium linked to structural factors, including the energy transition and the potential increase in military spending in the Old Continent'.