The European Bond Market & Recession

 The European Bond Market

The Lowest Point

During Covid-19, the European and US bond market hit their lowest yields ever due to ultra-loose monetary policies of the major central banks, including the ECB & Fed, that made bonds very unattractive for investors to invest in. For instance, US 10 bond yield hit 0.318% and many countries in Europe also hit their lowest point ever and even some of them traded in negative for the first time such as France's 10-year bond. Therefore, Only the extreme risk-averse or those under a mandatory obligation of investing in European markets were investing in European bonds. However, the European bond market is one of the biggest bond markets in the world, following the US and China.

The Recession

There is a widening acceptance that we're going to be seeing Germany in particular, but also the eurozone heading into recession in the first quarter of next year," StoneX strategist Fiona Cincotta said. There are many recessionary forces here such as double-digit inflation figures, the Russia-Ukraine war, the energy crisis, decreasing consumer confidence, etc. In addition to that, M2 money supply growth is about to turn negative year-over-year for the first time in history. Therefore, These difficulties are forcing governments to spend big to protect consumers and businesses, meaning more bond supply will hit the markets in the coming months and that can also lead to a rise in bond yields.

What the Yield is Telling? 

There are some points that you should know before investing in bonds. First, although the nominal rate is looking very attractive due to the rate hikes but the real rate of return on bond yield is negative as the UK 10-year bond yield is 3.6% and the inflation figure is 10.7% (real rate of return is -7.1%); and in Eurozone, the inflation is at 10.1% with 4.3% of average 10-year yield (real rate of return is -5.8%). Second, the current yields in the US and Europe are not reflecting the terminal rates of the fed, ECB, and BoE. There can be two reasons for that first can be that central banks will not raise the fund rate because of a slowdown in the expected inflation and the second can be the recession worries all over the Europe and US, there is also a fact that supports this statement is inverted bond yield, means 2-year bond yields are higher than the 10-year bond yield. The negative spread is 55bps in the USA, 9bps in the UK, and 20bps in Germany. The last time it was happened during the 2008 financial crisis.

What Should An Investor Do?

The European bond market is considered to be the safest investment destination if we exclude a few countries. There are many investors who are considering bonds a good investment now because equity is not looking attractive enough as the major equity indices around the world in the red since the beginning of the year, on top of that, expected to give very low returns next year. Meanwhile, interest rates on bonds have been rising and attracting investors to invest due to rate hikes. Therefore, there is a strong reason for investing in European bonds, especially the ones issued in larger countries such as Germany, France, the UK, etc. The only thing to be mindful of is that interest rates are going to go up even more, probably changing course somewhere in the middle of next year. So if one wants to time their investments, they may wait for another 3 months. If someone wants to average down their investments over a period of time, starting now is not bad.