The view from the Core CIO Office

Alessandro Tentori

CIO Europe European government bonds: Liquidity-driven valuations

Fixed income investors might have noticed the rather large swing in the valuation of German government bonds (Bunds) relative to interest rate swaps in the post-COVID-19 period. In the two years to September 2022, Bunds became expensive relative to the interest rate swap curve. Since then, there has been a 100-basis-point (bp) cheapening of Bunds versus swaps. This has erased the "natural margin" that risk-free bonds should have relative to risk-bearing bonds in our view. 

Looking at the Bund swap spread from a microeconomic perspective opens the door to variables like excess demand and collateral scarcity. These variables are linked with the activity of the largest bond player during the past decade: the European Central Bank (ECB). The chart below shows the relationship between the ECB’s footprint on the European government bond market and the Bund asset swap spread. The post-pandemic quantitative easing impacted the perceived scarcity of Bunds, thus raising liquidity concerns for Europe’s benchmark bond and pushing relative valuations to extreme levels.

Similarly, the ECB’s decision to dial back its unconventional monetary policy operations from July 2022 put a lid on the liquidity spectre and reversed the course of Bund spreads. Indeed, other European government bonds have cheapened against swaps as a result of the reduction in ECB buying and concerns about increased supply. For some investors, this will have made European government bonds a more attractive fixed income asset relative to both swaps and corporate bonds.

Ecaterina Bigos 

CIO Asia ex-Japan Region in waiting

Asia’s macroeconomic environment has become increasingly challenging from a growth, monetary policy, and currency perspective. Trade tariffs, the Federal Reserve’s (Fed) interest rates path and U.S. dollar strength make up the overarching headwinds. The U.S. policy agenda on tariffs is the biggest direct vulnerability given many Asian countries run some of the largest bilateral trade surpluses with the U.S., but also indirectly, due to relatively high economic interdependency with China. While inflation eased in most Asian economies in 2024, the average remains above most central bank targets, hence the region's low real rate relative to a stronger U.S. dollar and higher core rates add to its challenges. Fed policy path remains critical as it could intensify capital outflows from countries that ease rates too aggressively. Even in an environment of more measured tariff hikes, investor flows are likely to maintain a dollar bias. Most Asian currencies have depreciated against the greenback, particularly in the fourth quarter of last year, driven by the potential for fewer Fed interest rate cuts. Currencies will likely be the pressure valve for adjusting to any growth shock from tariffs, with intraregional correlations likely higher initially, before policy choices, domestic imbalances, and relative fiscal space in the various economies drive divergence.

Betas calculated over last two years, except for INR where betas are calculated during the peak of trade wars during President Donald Trump’s first term (and before the low FX policy volatility regime since late 2018).

Asset Class Summary Views

Views expressed reflect CIO team expectations on asset class returns and risks. Traffic lights indicate expected return over a three-to-six-month period relative to long-term observed trends.

CIO team opinions draw on AXA IM Macro Research and AXA IM investment team views and are not intended as asset allocation advice.

*AXA Investment Managers has identified six themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Technology & Automation, Connected Consumer, Ageing & Lifestyle, Social Prosperity, Energy Transition, Biodiversity.