Bond Bulletin

Bratwurst vs. burgers – Examining the underperformance of Bunds relative to Treasuries

Bond Bulletin
Bond Bulletin
GFICC Investors

Published: 6 days ago

The FQT research framework

Functional factors

Include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings, and leverage metrics).

Quantitative valuations

Is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors).

Technical factors

Are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum.

With 10-year German Bunds underperforming US Treasuries by 35 basis points year to date, this week’s Bond Bulletin looks at the reasons behind Germany’s recent underperformance.

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Fundamentals

While the focus of bond markets in 2024 was on the pace and extent of rate cutting cycles, the underperformance of German Bunds vs. US Treasuries year to date suggests that bond markets are currently being driven more by fiscal and political concerns than by monetary policy differentials. In Germany, the uncertain political landscape following the election has led to ongoing coalition negotiations, with a key debate centred around fiscal policy and the potential reform of the debt brake. With the centrist parties lacking the two-thirds parliamentary majority needed to implement major constitutional changes, fiscal reform is now more complicated. Increased spending (for example, on defence) could theoretically be achieved under the majority from the outgoing Bundestag or through alternative workarounds, such as by declaring an economic emergency or through the creation of special purpose funds, but the fiscal and political ambiguity has clouded the investment case for German Bunds. In the US, by contrast, political certainty has replaced the election-related instability of 2024, although the ongoing uncertainty over the economic impact of tariffs continues to hit sentiment.

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Quantitative valuations

The narrative of US exceptionalism was a key factor in the lack of Treasury demand. While this theme is fading, it has not yet led to a relative shift from US Treasuries to Bunds. Instead, the narrowing Bund-Treasury spread suggests that the market still views Treasuries as the preferred safe-haven asset, likely due to Germany’s unresolved fiscal outlook. The steepening of the Treasury yield curve has been quicker than the steepening of the Bund curve, further enhancing the relative attractiveness of Treasuries. The front end of the Bund yield curve is looking increasingly anchored, absent a negative shock. Without a front-end rally, the room for 10-year Bunds to rally is constrained. Also adding pressure to the long-end of the curve is the potential for a term-premium shock, driven by possible fiscal stimulus or increased European defence spending.

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Technicals

Supply and demand imbalances have contributed to the underperformance of Bunds. Although Germany's net issuance has increased, the German Finance Agency (GFA) is addressing funding needs through flexible instruments, such as short-term issuance and repo transactions, rather than through a significant increase in Bund supply. However, if fiscal policy shifts towards greater expansion, the potential for higher net Bund issuance remains a risk. Additionally, the potential increase in European defence spending introduces another layer of uncertainty. While Germany has committed to higher military expenditures, broader European discussions suggest that financing will be shared across multiple countries, rather than relying predominantly on Bund issuance. Some defence spending may be funded nationally, but there is also momentum towards European Union-backed financing, including joint European bonds or a relaxation of fiscal constraints for military investments. The lack of clarity has weighed on Bund performance, as investors await further details on potential issuance implications. The US is also not immune to a lack of fiscal clarity, yet investors still see Treasuries as a superior safe-haven asset, and the recent indications of a more fragile growth environment are behind this: the US composite purchasing managers’ index fell to a 17-month low at 50.4 in February, indicating GDP growth expectations are now at 0.6% for February, down from 2.4% in December 2024. January’s non-farm payrolls data showed 143,000 jobs were added, significantly below expectations, while jobless claims are ticking up. The market absorbed $2.7 trillion of gross Treasury supply in January alone, representing a 7.1% increase over 2024 due to front-loaded borrowing needs. US supply and demand dynamics will be further influenced by the pace of quantitative tightening by the Federal Reserve (the Fed). Recent indications of a slowdown in the reduction of the Fed’s balance sheet could reduce term premium and supply pressures, and lower long-term Treasury yields, which in turn could cause a further narrowing of the Bund-Treasury spread, if Bund yields remain elevated due to fiscal concerns and potential issuance increases.

The spread between US 10-year and German 10-year bonds has narrowed since the beginning of the year

The spread between US 10-year and German 10-year bonds has narrowed since the beginning of the year

Source: Bloomberg; data as of 26 February 2025.

What does this mean for fixed income investors?

The narrowing Bund-Treasury spread highlights that fiscal risk and supply concerns can outweigh monetary policy expectations. While Bunds are traditionally seen as a core defensive asset, their relative underperformance vs. US Treasuries suggests that investors are demanding greater risk premia. If Germany fails to deliver fiscal clarity, the spread between Treasury and Bund yields may remain tight for some time. As such, the key determinants of near-term Bund relative performance will be Germany’s coalition negotiations, defence spending plans, and broader fiscal policy adjustments.

About the Bond Bulletin

Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.

Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.



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GFICC Investors

Published: 6 days ago

The FQT research framework

Functional factors

Include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings, and leverage metrics).

Quantitative valuations

Is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors).

Technical factors

Are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum.

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