Horizon Q1│2025 - Bonds
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In a nutshell
Safe government bonds look attractive for hedging purposes, but offer little return potential.
European corporate bonds offer at least fair, and in some cases attractive, yields.
Emerging market local currency bonds offer the prospect of positive returns.
Bond markets between politics and economics
The final quarter of 2024 was dominated by politics: in addition to the ongoing Russian war against Ukraine and the conflicts in the Middle East, the US elections and the “red sweep”, as well as the collapse of the German government coalition, complicated the situation. The consequences of these developments will not leave the bond markets untouched in the new year. What can we expect from the various segments of the fixed income asset class in 2025?
Safe government bonds with a cautious outlook
Unsurprisingly for us, the strong third quarter was followed by a weaker fourth quarter – yields rose on both sides of the Atlantic. All in all, 2024 was a mixed year for safe-haven government bonds and could be a foretaste of 2025, as we do not expect yields to provide significant support over the next 12 months. Although the fall in inflation will allow central banks to continue their rate cuts, monetary easing will not be as strong as was expected a few months ago. In the US, optimism about rate cuts has been severely dampened as the change of government is likely to be accompanied by higher tariffs, stricter immigration policies, increasing price pressures and rising budget deficits. However, even in Europe, inflation will not return to pre-pandemic levels, which means that there is no room for yields to fall unless there is an economic slump or a further escalation of (geo)political conflicts. Against this backdrop, we consider safe government bonds to be of interest only as a hedge.
Safe government bonds offer only modest prospects
Past and expected performance of 10-year government bonds, overall effect of yield/price change, coupon yield and roll-down effect
Forecasts: Key interest rates and government bond yields (in %)
Berenberg and consensus forecast in comparison, values at mid-year 2025 and at year-end
Corporate bonds: Perspective matters
Corporate bonds were the main beneficiaries of 2024 – the higher the credit risk, the better the performance. Better-than-expected economic performance in much of Europe and the US, as well as continued capital inflows, boosted demand. After the strong performance, however, risk premiums in the investment grade segment can still be described as fair at best and in the high-yield segment as increasingly unattractive. A look at yields, however, tells a different story and reveals fair and in some cases attractive valuations by historical standards. This is particularly true when compared to the negative and low interest rate environment from 2014 to mid-2022. The combination of these two views, together with a more expansionary monetary policy and an expected stable economy, leads us to be cautiously positive on the corporate bond segment as a whole. However, further spread tightening is unlikely in 2025, meaning that the upside potential is likely to be capped by current yields. However, an increasingly likely market correction could brighten the somewhat gloomy picture and create opportunities for better valuation levels.
Corporate bonds: yield levels remain attractive
Euro-denominated corporate bond yields since the European Central Bank cut the deposit rate into negative territory for the first time in June 2014
Emerging markets: focus on the “phoenix from the ashes” countries
Donald Trump’s election victory has recently been a clear driver of investor sentiment towards emerging market bonds, both local and hard currency. This is likely to continue in the first quarter of 2025. A restrictive tariff and immigration policy, as well as an unpredictable US foreign policy, are already a clear focus for emerging markets. So is there anywhere safe within the emerging markets asset class? The clear answer is yes, there are indeed emerging market issuers that have regained investor confidence thanks to fiscal reforms and the successful implementation of economic policy conditions imposed by the International Monetary Fund, as well as the strengthening of institutional independence from fiscal and monetary policy. These positive “recovery stories” have outperformed the broader emerging markets because of their idiosyncratic nature. This applies to both hard currency and local currency bonds. This trend should continue into the first quarter of 2025. Among the so-called “recovery stories” are Turkey, Egypt, Argentina, Serbia and India. An equal-weighted basket of these countries outperforms a broad local currency index in 2024 (bottom right). With high real yields, stable fundamentals, moderate currency risks versus the euro and low correlation to other asset classes, we see good opportunities for positive returns, particularly in the local currency segment.
Emerging market bonds: country selection continues to pay off
Performance of an equal-weighted basket of EM currencies (Turkish lira, Egyp-tian pound, Argentine peso, Serbian dinar, Indian rupee)
Conclusion: Our favourites are unchanged for 2025
After a weaker final quarter of 2024, safe-haven government bonds are unlikely to rally significantly in 2025. Only in the event of an economic downturn (not expected in our main scenario) or an escalation of geopolitical risks should they prove their worth as a hedging instrument, but otherwise they do not offer particularly attractive prospects. Euro corporate bonds should be viewed in a differentiated manner: They are expensive in terms of risk premiums, but still offer interesting opportunities in terms of yield levels. They are also supported by the ongoing interest rate cuts by the major central banks. In emerging markets, our focus is on recovering economies that have already demonstrated their potential last year and should continue to do so. Our main focus is on the local currency segment. The bottom line for 2025 is that if you want to make money from bonds, you have to take risks.
Authors
Martin Mayer
Martin Mayer, CEFA, has been working as a portfolio manager since 1998. Since November 2009, as Senior Portfolio Manager at Berenberg, he has been responsible for the pension strategy of private asset management and for individual special mandates. After completing his training in business administration (Wirtschaftsakademie) and his degree in economics (University of Hamburg), he joined Deutsche Bank's asset management department in 1998. Until 2008, he managed individual client portfolios for Private Wealth Management and completed further training as a CEFA investment analyst/DVFA in 2001/2002. Mayer joined HSH Nordbank in the summer of 2008 as Deputy Head of Portfolio Management.
Martin Mayer
Senior Portfolio Manager Multi Asset
Felix Stern
Felix Stern joined the Asset Management division of Berenberg in 2000 as a fixed income portfolio manager. Currently he is heading the fixed income selection team within the Asset Management and is responsible for institutional mandates. As a senior portfolio manager he is responsible for the selection of corporate and financial bonds as well as short-term bond market investments. He is also the lead manager for several of Berenbergs institutional mutual funds. Prior to joining Berenberg, he worked several years for the Market Research department of British American Tobacco, Germany. Felix is a CCrA - Certified Credit Analyst (DVFA) and also has a German Diploma in business economics from the Fernuniversität in Hagen.
Felix Stern
Head of Fixed Income Euro Balanced
Wei Lon Sung
Head of Fixed Income Emerging Markets
