Insurance Markets

Diversifictation is the port in the storm

High costs of state rescue packages for countries in the European periphery, inflation concerns due to lax monetary policy, fear of a decade of deflation as already seen in Japan: the question again arises of whether we can continue to expect very low yields or whether rapidly rising yields for German government bonds (bunds) are more likely over the long term – as does the question of what this will mean for investment strategies.


A commentary by Dr. Jürgen Callies

Interest rates at a crossroads

As we see it, German interest rates have reached a crossroads. In the current situation there are arguments that speak for rising as well as arguments that speak for falling interest rates, and the decisions laid by politicians (re: euro debt crisis, central banks, budget deficits) are becoming ever more important. The 30-year downside interest trend appears to be giving way to a broad sideways one in yields, but despite that we have to be prepared for a period of low interest. If one looks back at the yields of government bonds, a long-term downward trend started at the beginning of the 1980s that was ushered in by the stability policies of the Fed and the Bundesbank. Other triggers were stable/falling commodity prices up to the start of the new millennium, greater liberalisation and deregulation of the markets and the large-scale formation of foreign currency reserves in the BRIC countries. Furthermore, the historical crises ( bubble, credit crisis) at the beginning of the new millennium led investors to increasingly search for safe havens, adding momentum to the downhill ride of government bond yields in Germany and the US.

Countervailing trends in interest rates

This will only apply partially in the future. We probably cannot expect to see commodity prices falling for a longer period or a stability-oriented monetary policy, as in the 1980s and 1990s, in the near future. Indeed, strong growth in the emerging markets is maintaining the upward pressure on commodity prices and the central banks seem to have goals other than price stability, at least for the moment.

In contrast, the opening-up of markets, productivity gains, above all in the emerging nations and the service sector, and only moderate wage pressure increases will have a tempering effect on inflation and hence on interest rates. Moreover, demographics are becoming more important, especially in the industrialised countries, and causing increasing demand for long-term bonds in particular.

High yields of 1970–2000 unrealistic

If one considers the various factors influencing interest rates, the downtrend in Germany should have come to an end now, with yields on ten-year bunds at around 2%. Ranges of 6% to 9%, as seen for ten-year government bund yields in the 1980s and 1990s, are unrealistic. From today’s point of view, ten-year yields could find their level at around 2% to 5.5% in the next ten to 20 years, although we expect this range to be between 3% and 4% for much of that period. This would mean that German bunds will remain in a low-yield environment for some time to come. Given current fears that the currency union may fall apart at the seams, the safe-haven function of government bonds could also put downward pressure on yields in the short term.

If the crisis deepens, yields will fall further

The ongoing euro crisis shows that there is no longer such a thing as a totally safe investment. Even if German bunds are among the few securities to which this characteristic is ascribed, they can be affected in very different ways by the euro debt crisis. In the long term, there are three ways to master the crisis.

A combination of reforms, saving, privatisation and the regaining of a growth dynamic in crisis-struck countries would be desirable. But if this fails, what remains is the transfer union or one or more member states could even actually fail.

While a worsening of the crisis would mean even lower yields, the transfer union would probably lead to falling prices and rising yields for government bonds in the medium term.

The maxim is: Diversification

Investors would be well advised not to rely solely on safe-haven bonds like bunds but to adhere to tried and trusted principles: it is important to diversify between regions and asset classes. Emerging markets and new investment categories such as renewable energies should be included in the range. Alongside that, liquidity is of special importance. Because circumstances can change quickly and demand fast and flexible reaction, a significant share of investments should be in liquid assets.

Munich Re Experts
Jürgen Callies
Jürgen Callies
studied economics and gained a doctorate in technology and foreign trade.He has been active in various fields of capital market research for more than 20 years, and in charge of the Research unit at MEAG since 2002. MEAG, the investment manager of Munich Re and ERGO, currently manages investments valued at around €203bn.