On the one hand, there are those who would be more cautious about raising rates with a more gradual trend (this is the case, for example, of the Governor of the Bank of Italy, Ignazio Visco) in order to accompany monetary policy with budgetary policy, and on the other hand, there are those who fully endorse the moves and the pace dictated by the Fed and the ECB as the only medicine to bring inflation back to acceptable levels. But whichever way you look at it, it is undeniable that interest rates play a key role in the European economy. It always has been, but at this stage with such a sudden rise in prices it becomes even more so. The monetary policies of the central banks, together with a number of global economic factors, have strongly shaped their course. Europe, immediately after the Covid-19 pandemic, found itself in a particular phase of economic transition. On the one hand, the ECB, in order to stimulate economic recovery, reiterated accommodative monetary policies for far too long, keeping interest rates at very low, near-zero levels, trying to encourage spending and investment.
On the other hand, the real game changer, in this case with a negative meaning, was and still is inflation. After a period of moderate inflation, the whole world has seen consumer prices skyrocket, due to a number of factors ranging from bottlenecks in production chains, to war, to the effects of fiscal and monetary policies that were precisely too expansionary for too long. The central banks, despite initially continuing to talk about a transitory event, have intervened since early 2022 by rapidly raising interest rates in order to contain it, but this has direct consequences on the real economy (high financing costs) and weakening consumer and investor confidence.
"All this led to a situation not seen for many years on government bond markets, namely a sudden and uncontested rise in rates even in those countries that until then had been considered risk free such as Germany," commented Luca Longhi, Head of Total Return Portfolio at Banca Generali. "In fact, while in Italy or other countries such as Greece, Spain and Portugal we were used to periods of abnormal volatility such as 2011, remembered as the year of the sovereign debt crisis, German securities experienced volatility that had not even been seen in the great crisis of 2008, which had affected the equity asset class more and had pushed investors to take refuge in government bonds."
For example, if we look at a German 10-year bond maturing in 2020 to date, we will see that, despite such a narrow time range, a minimum yield of -0.86 was reached (2 March 2020) up to a maximum of 2.74 less than three months ago. In Italy, deviations between lows and highs of almost 4.5% were reached.
The dispersion in performance among European sovereign bonds since 2022 has been influenced by a number of factors, including economic conditions, monetary policies, country risk profiles and geopolitical dynamics. This dispersion has created challenges for investors but also opportunities. In light of this new environment, in order to address the challenges and seize the opportunities offered by bond markets, it is necessary to actively act on the portfolio.
"The benefits of active management are manifold but, having to highlight the main ones, diversification, return optimisation and risk management are the most relevant. Active management allows investors to adapt quickly to changes in market conditions and yield fluctuations, which is particularly relevant in times of volatility or when idiosyncratic events occur on individual countries, by adjusting duration, for example," Longhi comments. "In terms of optimisation, active management allows savers to take advantage of diversification opportunities, since, as seen before, sovereign bonds of different countries can present differentiated returns and risks and this allows the manager to work in relative terms, optimising the risk/return profile of the portfolio."
Luca Longhi, Head of Total Return Portfolio at Banca Generali
All this led to a situation not seen for many years on the government bond markets, namely a sudden and uncontested rise in rates even in those countries that until then had been considered risk free such as Germany.
