1 week Ago
At a scary moment when almost no place in global markets looks safe, Germany’s recently rocky government bonds may be one of the few true havens left. A week of precipitous global stock market losses driven by Washington’s unfolding trade war took an alarming turn last Tuesday as offsetting safety bets in US Treasury bonds turned sour too. The wild and unpredictable ride continued late on Wednesday.
Even while writing this piece, market tables were upended again as President Donald Trump blinked in his tariff campaign and paused his so-called reciprocal import levies for 90 days for all except China. Stocks jumped a mind-blowing 8 per cent – but it’s anyone’s guess how long that lasts. Whatever happens next, the market playbook up to that point sets a jarring precedent for the inevitable next convulsion.
Treasuries had been behaving well again this year as a portfolio buffer, surging in value as equities tanked on tariff fears. Indeed, the correlation between the two asset classes actually hit its most negative in two years last week. But that correlation flipped violently again this week.
As an example of how that affects savings pots, exchange traded funds that track standard 60/40 equity/bond portfolios , which had been fairly serene from November’s election right through the turbulent first quarter, tanked 8 per cent since the US tariff plan was first laid out last Wednesday. The twin stock/bond selloff seems to have had many triggers, including the escalating US-China tariff battle, fears that traders’ margin calls in risky bets were leading to liquidation of safe assets and a perceived reluctance of the Federal Reserve to ease credit. All may have been at play, but the burgeoning narrative now is that overseas investors are fleeing American assets at large due to the seemingly chaotic nature of Donald Trump’s trade war.
With total US investment liabilities to foreign savers standing at more than $62 trillion at the end of last year, that thought is alarming to say the least. Goldman Sachs currency strategist Michael Cahill said US assets and the dollar were being hit by recessionary fears and high uncertainty about the endgame in the trade war as well as a growing worry about the stability of US institutions. “Negative trends in US governance and institutions are eroding the appeal of US assets for foreign investors,” Cahill told clients this week.
The capital flight argument should be especially worrying for US savers and retirees nursing expensively priced investments, pumped up for years with overseas money drawn in by the US “exceptionalism” theme. Those worries often, understandably, home in on China, not least due to its $760 billion of Treasury holdings, which could potentially be weaponized if the trade war escalation continues. But much of the additional foreign money that flooded into America’s megacap stocks and relatively high-yielding bonds over the past decade was mostly from Europe.
And scared money tends to go home. BUNKER BUNDS As US Treasuries sold off violently this week, Europe’s traditional safe haven – Germany’s government bunds – rallied sharply. So much so that the yield premium of US versus German 10-year debt surged 30 basis points this week to some 170 bps – the widest spread in a month.
Even though bunds were jarred in March by the new German government’s trillion euro defence and infrastructure spending push, they have roared back since, despite an intensifying trade war that has major ramifications for euro area growth and European Central Bank policy. But what has been truly notable this week is that bunds behaved like a safe haven when Treasuries didn’t. The extent to which this countervailing bund rally is driven by transatlantic repatriation is unknowable, but what can be safely assumed is that any returning European money won’t necessarily go back to European equities, not yet at least.
So the bund market seems like the logical option. Indeed, there appear to be few doubts that the country is ‘money good’ even if its debt/GDP ratio is set to rise. Just look at the rock bottom German sovereign credit default swap pricing and the benign reactions of credit rating firms to the German fiscal stimulus.
“German Bunds offer better value as a safe haven with yields still elevated after the recent shift in fiscal policy,” HSBC’s global head of fixed income Steve Major told clients. Major argues that if the ECB was to cut rates by more than forward markets now imply, bund yields have significant scope to fall across the curve and “are a good alternative safety play to US Treasuries.” While the modest size of the German bond market may mean it would have more difficulty absorbing a headlong dash for safety compared to the huge Treasury market, the supply of bunds is rising and there are higher yielding alternatives in the well supplied government debt markets of its euro zone partners.
Ultimately, the prospect of Germany, and Europe more generally, becoming a comfortable home for funds seeking safe assets has profound implications for the euro and dollar’s respective roles in sovereign currency reserves. The return to Europe has taken on many forms this year. But the retreat to its debt havens may be one of the more meaningful.
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