Two bond stories from two sides of the English Channel

I have been sharing some of my observations on the different bond markets during my travels this summer. Up next on our global bond tour: Europe. I recently had a chance to visit London and meet with investors there. What I found was a U.K. market that had many similarities to the United States and Canada, but across the English Channel, the European continental market looks much different. Let’s explore.

United Kingdom offers some value

At first glance, the U.K. bond market bears some resemblance to the United States and Canada. As of July 31, the 10-year U.K. bond yield is 0.83%, a bit below the 1.58% of the United States, but still positive (source: Bloomberg). And if you look at short-term interest rates , they are at 0.50% with expectations of a gradual rise over the course of the year (source: Bank of England). Sounds a lot like the states, and sounds a lot like Canada . Australia also fits into this same category: developed bond markets with positive interest rates and central banks that have kept short-term rates low and accommodative.

Everything is coming up negative

Looking across to continental Europe, however, we see a very different picture. The European Central Bank (ECB) has been very aggressive in not only setting short-term interest rates at 0%, but also aggressively buying bonds to push longer-term rates down. Even before Brexit, Europe was faced with declining growth and near zero levels of inflation. In an effort to boost the economy, the ECB has embarked on a large scale quantitative easing program. It ended up buying not only government bonds, but more recently, corporate bonds as well. As a result, yields on most European debt has plunged. As of July 31, the yield on a 10-year German bond was -0.12%, while the yields on 10-year bonds from other continental European countries were low to negative, according to Bloomberg data. And it gets worse. If you look at short-term bonds, as illustrated in the chart below, yields on two-year notes in Germany, France, Italy, Spain, Sweden, the Netherlands and Switzerland were all negative.

No good bargains in continental Europe

Given the disparity, how should a U.S. investor think about the European bond market? I’d suggest we group the United Kingdom together with the United States, Australia and Canada, developed markets that have offered some yield in a world where yield is disappearing. But continental Europe is a much tougher challenge. You have had either negative yields on highly rated bonds from countries like Germany, or low yields from lower quality issuers like Italy and Portugal. Italy is a BBB issuer, meaning its bonds are among the lowest rated investment grade bonds out there, and yet they pay a lower yield than U.S. Treasuries. Taken together, it is hard to see much value for U.S. investors in continental European bonds at current levels.

Matt Tucker , CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog .

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