With yields on eurozone government bonds having undergone a jump of around 0.50% since the pressure valve was released in April – led by German bunds increasing almost ten-fold in one day – fixed income investors are having to rethink their plan of attack.
Luca Paolini, Pictet’s chief strategist, has subsequently reallocated some of his bond weightings – a decision he explained was in spite of the prospective benefits stemming from the European Central Bank’s loose monetary policy.
“With European speculative-grade fixed income securities having returned about 3% more than government debt so far in 2015, we believe it makes sense to scale back our exposure to high-yield bonds to neutral,” he said.
Although high-yield bonds should draw support from the eurozone’s economic recovery and the ECB’s heavy dose of monetary stimulus, Paolini explained, the asset class’s yield spread looks increasingly unattractive compared to that offered by Italian or Spanish sovereign debt.
“We have also upgraded sovereign debt to neutral from underweight,” he added. “Amid the recent sell-off in government bonds, the yield gap between Italian and German sovereign debt widened by about 50 basis points. Similar shifts have occurred in Spanish bond markets. In our view, these yield differentials are unjustifiably high, particularly as the ECB remains focused on keeping a lid on the borrowing costs of economies in the euro zone’s periphery.”
“As such, we are overweight long-dated Italian and Spanish government bonds. More broadly, we believe government bond markets could evolve into a rich hunting ground for tactically-oriented investors over the coming months as market interest rate expectations are becoming increasingly volatile,” Paolini said.
