Same Shock, Different Cushions: 10-Year Bonds Across Europe

We recently looked at the asymmetry in US Treasuries. Maxence Brands, portfolio management intern at ECP, run the same exercise across Europe. The result tells a more nuanced story.

The chart shows the 12-month return of 10-year government bonds in three scenarios: yields rising by 1%, unchanged, or falling by 1%. In every market, a 1% fall would return between roughly 10% and 13%, while a 1% rise would cost between 1% and 4% in most countries.

In practice, the cushion provided by carry varies widely from one country to another. UK Gilts and French OATs, with the highest yields, would lose only 1.2% and 1.9% if yields rise by 1%. German Bunds would lose 3.8%. Swiss bonds, yielding barely 0.5%, would lose 7.8%. In simple terms, the higher the starting yield, the more income there is to absorb the shock.

But a higher yield is not a free lunch: it is paid for a reason. The extra income protects you when rates rise across Europe. It does not protect you when the problem is the country itself. If investors lose confidence in one government's finances, its yields can jump far more than 1%, and the cushion is quickly wiped out.

At ECP, we remain convinced that duration is becoming interesting again, in Europe as in the US. In Europe, however, selectivity is part of the trade: the cushion is only as good as the credit behind it.