Among veteran market participants, there is a pattern of behavior that is sometimes mockingly claimed to be hard-wired into their brains: In turbulent times, buy government bonds. When an unexpected negative event occurred, the price of perceived safe-haven government bonds usually went up. That could have compensated for losses on other investments. Over the past decades, this negative correlation to risky assets has served many market participants well.
In this respect, the pattern observed for European government bonds in 2020 is unusual. Since the middle of February the biggest economic catastrophe in post-war history is unfolding. Nevertheless, German government bonds, known as Bunds and widely considered among the world's safest investments, are trading at roughly the same level as they did two months ago.
Of course, Bund yields have not been completely unaffected by the Covid-19 crisis. At just under -0.9%, the yield on 10-year Bunds recorded a new low on March 9. Since then, however, yields have risen again, in some cases substantially above pre-crisis levels. Even more interesting is why yields have behaved like this. Nominal yields can be broken down into two components, namely real yields and implicit inflation expectations. As our "Chart of the Week" shows, yield declines between mid-February and early March were mainly caused by falling inflation expectations. However, the rise since then has been driven by rising real yields. According to economic theory, real yields should reflect (real) growth expectations. That would mean that the market currently has a more optimistic view on the growth outlook compared to the beginning of February.
How do we interpret these developments? For one thing, bond yields do not seem to fall quite as quickly once they become negative, says Dr. Jörn Wasmund, Head of Fixed Income at DWS. However, this does not necessarily suggest the existence of an absolute lower limit, below which yields can never fall. After all, the experiences of the last few years have taught market participants and economists alike never to say "never." Most important for the interest-rate trend, however, are the central banks' current and expected purchase programs. Such programs restrict the free play of market forces and thus deprive textbook forecasts of their basis. Interest-rate forecasts thus become forecasts for central-bank behavior.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 4/22/20