Will Bunds bounce back against US Treasuries?

If we look at the main drivers of returns in Q1 2025, the first one that comes to mind is tariffs. But while this is true for equities and credit spreads, in the context of global fixed income the main driver of total returns in Q1 was the Bund sell-off triggered by a momentous shift in German fiscal policy. Even this is not the whole story, since the fact that one of the most violent moves in Bunds in decades happened alongside a rally in US Treasuries (USTs) is equally important and unusual.

Quarterly returns for the last 30 years show Bund and UST returns have been on opposing sides of zero close to 20% of the time (we are using the ICE 7-10yr US Treasuries and 7-10yr Bund indices to simplify the calculation). In other words, it is relatively rare, but it does happen. Looking at the magnitude of the difference in the red bar on Exhibit 1 below, in Q1 2025 USTs returned 3.9% while Bunds returned -1.8%, a performance gap of -5.7%. In the last 30 years, this quarterly performance gap has only been larger on one occasion, in Q1 2020. This was when Covid-19 hit and all government bonds rallied, but Bunds rallied a lot less than USTs because interest rates in the Eurozone were at rock bottom levels. In that quarter, USTs were up 10.3% while Bunds returned 2% for a performance gap of 8.3%. The podium is completed by Q2 1995, when USTs rallied by 8.2% and Bunds returned 2.7% for a performance gap of 5.5%.

While it is impossible at this stage to know whether this underperformance by Bunds will reverse or not, a look at what happened after Q1 2020 and Q2 1995 might shed some light. Across the four quarters that followed Q1 2020, Bunds outperformed USTs by 5.2%. Across the four quarters that followed Q2 1995, Bunds outperformed UST by 6.7%. If we look at the fourth largest gap in quarterly performance over the 30 years, in Q1 2021, it was USTs underperforming Bunds by 4%; across the four quarters that followed, USTs outperformed Bunds by 3.1%.

To be clear, we are not saying that Bunds will outperform over the next four quarters based on this analysis; the difference in Q1 2025 performance was driven by “flight to quality” factors in the US and fears around increased spending and borrowing in the Eurozone. However, it is worth keeping in mind that when severe moves occur in financial markets, especially in the case of two assets that have similar characteristics such as zero default or extension risk, the relative value between them does change. The substantial yield premium that Bunds offer once adjusted for FX hedging (which adds approximately 200bp to euro yields once hedged back to US dollars) will appeal to investors that can take advantage of it. And given the absence of default risk, it should mean there is a ceiling as to how high Bund yields can go in isolation before the correlation to USTs returns to historic norms – we have in fact seen a move in that direction in the last few days.

We are not calling a substantial Bund rally. We remain of the opinion that carry will be the most important contributor to returns in 2025. But we do think it’s wise for investors to take note of shifts in relative value when quarters like this occur, particularly when the source of the underperformance is positive news for the Eurozone economy, which should lend support to risk assets in the region. However, until Germany’s spending details are finalised and public, we expect Bunds, along with other Eurozone government bonds, to remain volatile.