Which bond strategy is appropriate in the current interest rate environment?
Declining consumer prices and stable inflation expectations in line with central bank targets have led to a significant drop in key interest rates in Europe within a year. But what does the future hold – and what are the implications for positioning in the bond sector as a key component of a diversified portfolio? Our latest analysis provides the answers.
Headquarters of the European Central Bank (ECB) in Frankfurt am Main
Interest rate reduction cycle
The cycle of interest rate cuts is well advanced in the eurozone. Within a year, the European Central Bank has lowered its key interest rate from 4% to 2%. A break in interest rate cuts is therefore drawing nearer. The situation looks similar in Switzerland. The Swiss National Bank has reduced its key interest rate from 1.75% to 0% within 15 months and is likely to have reached the end of the interest rate reduction cycle. The fact that no substantial economic stimulus occurred during the negative interest rate phase before 2022, while the Swiss franc remained strong, suggests that a return to negative rates is unlikely. Furthermore, a continuation of ultra-loose monetary policy entails certain risks, such as real estate market overheating and challenges in financing pension financing.
The situation in the US presents itself differently. After lowering its key interest rate by a total of 100 basis points in the fourth quarter of 2024, the US Federal Reserve has since maintained its interest rate at 4.5% despite declining inflation rates. This is due to concerns that rising tariffs could reignite inflation. The focus is on the tension between Fed Chairman Jerome Powell and US President Donald Trump, who demands significantly lower interest rates. The situation could ease if the tariff dispute subsides – or in May 2026, when Powell's term of office ends. One thing is certain: the US retains the widest margin for further interest rate cuts compared to other countries. The chart below shows future market participants’ expectations regarding future key interest rate cuts. Currently, a key interest rate of 3.85% is expected by the end of 2025, which corresponds to a decline of 0.65% or almost three interest rate cuts of 0.25% each.
Source: LSEG Datastream, Colin&Cie
Normalisation of the yield curve
For the period 2023/2024, we expected interest rates in the eurozone to fall for short maturities and the yield curve to gradually normalise. A ‘normal’ yield curve is characterised by bonds with longer maturities offering higher yields than those with shorter maturities. The chart below shows the interest rate development of German government bonds and confirms our assessment. While there was still an inverted yield curve as of 31 December 2023 and 31 December 2024, the curve has now returned to a normal pattern.
Source: LSEG Datastream, Colin&Cie
Medium to long-term interest rates
In terms of medium to long-term interest rates, we expect the US dollar, euro and Swiss franc to move sideways, with potential for the slight downward trend to continue. The chart below compares the yields on 5-year government bonds in the three currencies mentioned. It illustrates the yield advantage of the US dollar and the slide of Swiss franc interest rates into slightly negative territory. In both Germany and Switzerland, 5-year interest rates are currently at a level very close to the respective inflation rate.
Source: LSEG Datastream, Colin&Cie
Colin&Cie positioning and bond strategy
In addition to the yield curves of various currencies, the yield differences resulting from the creditworthiness or credit rating of issuers – such as governments or companies – also play a key role in positioning in the bond segment. For a solid investment strategy in the bond segment, issuers with a rating between AAA (highest creditworthiness) and BBB (good creditworthiness, investment grade) should be given priority. The interest rate differential, considering the term and creditworthiness, is decisive for assessing the attractiveness and risk profile of a bond.
The chart below showing current yields on European corporate bonds illustrates the yield spread between short-term bonds with the highest credit ratings – comparable to government bonds – and longer-term securities with slightly lower but still solid investment-grade credit ratings. To ensure an attractive risk/return profile, Colin&Cie is currently focusing on corporate bonds with good to very good credit ratings. Following the normalisation of the yield curve that we expected to see, we have already made some reallocations: relevant parts of our short-term positions (maturities of less than one year) have been shifted to bonds with remaining maturities of more than four years to better take advantage of the currently higher yield level. Where it makes sense, we plan to further expand this share. We consider the associated interest rate risk in the event of potentially rising interest rates to be acceptable in regard of the additional yield advantage.
Source: LSEG Datastream, Colin&Cie
Colin&Cie's objective in the bond segment is to achieve a return for clients with reference currencies in euros or Swiss francs that is at least equal to the rate of inflation. To achieve this goal, we focus on broad diversification across many issuers, which effectively reduces default risk. By bundling various bond purchases into a larger structure, our clients also benefit from easier market access and more favourable purchase prices.
Disclaimer - legal notice
This publication was produced by the Investment Office of the Colin&Cie Group. The information and opinions contained in this document are based on sources we believe to be reliable. However, we cannot guarantee the reliability, completeness or correctness of these sources. All information and quoted rates are only up-to-date at the time of this publication and are subject to change at any time without notice. The content is based on numerous assumptions made by the Colin & Cie Group. It should be noted that different assumptions can lead to materially different results. The forecasts and assessments are only current at the time this publication is prepared and can change at any time without prior notice. Past performance of an investment is not a guarantee of future results. Certain investments can experience sudden and substantial losses in value. This information and views do not constitute a solicitation, offer or recommendation to buy or sell investment instruments or to carry out any other transactions. We recommend interested investors to consult their personal advisor before making decisions on the basis of this document so that personal investment goals, financial situation, individual needs and risk profile as well as further information can be duly taken into account as part of a comprehensive consultation. The information contained in this publication is marketing material that is distributed for advertising purposes only.
