Why investors need to keep up with the changes in the sovereign bond playbook
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Article Type
Market Updates
Topic
Opinion
Published
May 18, 2026
Read time
5 mins
Author
Irina Kurochkina, CFA
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By Irina Kurochkina, Portfolio Manager, Aegon Asset Management

 

When geopolitical shocks hit financial markets, the instinct among investors is to reach for the nearest historical parallel. Since the Iran conflict began, I have seen many market participants anchoring their thinking to 2022, the year of surging inflation, an aggressive hiking cycle, and painful losses across fixed income. I understand the logic, but we are in a different scenario now, and getting that call right has real consequences for how you position a sovereign bond portfolio today.

 

In 2022, inflation was already running hot before the Ukraine conflict escalated. The economy was absorbing significant COVID-era government spending, genuine labour shortages, and a strong pent-up demand. Moreover, monetary policy was still loose, with low or even negative interest rates in core markets.

 

This time, many countries were either at or approaching their inflation targets when the latest shock arrived. Economic momentum is more fragile, which matters enormously for central banks, as it limits how far and how fast they can tighten without actively damaging growth.

 

In the early weeks of the conflict, European rates markets priced in up to four rate hikes for the year. This was clearly an overreaction, to some extent driven by forced selling. Central banks had signalled hawkishness, partly because they wanted to send a message that they would not be repeating the "behind the curve" mistake of 2022.

 

But there is a difference between communication strategy and actual policy trajectory. Since then, we have seen the tone shift: central bankers are increasingly acknowledging the growth impact of the shock and signalling that they would prefer to wait and see. While it is difficult to ignore the inflation pickup, any potential hikes would be rather cautious and slow. Investors should have been positioned to fade the initial overreaction, particularly at the front end of the European curve, to benefit from the normalisation in monetary policy expectations.

 

Duration

Active management of duration is a way to benefit from the current market environment. Daily volatility in rates markets, where five to ten basis point moves have become almost routine, rewards a tactical approach. We are trading around market-moving headlines, as overreactions in either direction create genuine opportunities for active managers.

 

That said, if central banks hike less than the market currently expects, longer duration assets should benefit. The ten-year part of the yield curve is getting more attractive outright as a way of expressing a view on the growth outlook. We would urge caution on the very long end, 15- to 30-year maturities, given that fiscal concerns are real and not going away. For example, many governments have announced energy support packages, which add pressure to already-stretched public finances. In combination with the lack of central bank purchasing programmes, there is simply less demand for that part of the curve, and the term premium is likely to stay elevated.

 

Spreads and the peripheral question

Credit spreads in sovereign markets tightened back quickly after the initial shock, perhaps too quickly, given the macroeconomic uncertainties that remain. Within the eurozone, investors should be reviewing exposure to countries with high budget deficits and significant dependence on energy imports.

 

Countries in Southern Europe have performed exceptionally well in recent years, and while I am not bearish on them outright, I am not willing to assume that run continues unchallenged. If the conflict persists and we see a disrupted tourist season - with flight cancellations and reduced consumer confidence - those economies may face headwinds worth monitoring carefully.

 

At the same time, the convergence story between “core” and “periphery” has not disappeared. Germany is itself issuing significantly more debt to finance defence and infrastructure spending, so most investors expect that spreads will move structurally lower. At the same time, in a more volatile and risk‑averse environment, an assumption that peripheral spreads will tighten indefinitely deserves scrutiny.

 

Diversification

One thing investors should feel strongly about is the importance of not letting home bias dominate a government bond allocation. I understand the historical rationale, but the current environment makes a compelling case for a broader approach.

 

In our global government bond fund, we target roughly five per cent average country exposure, compared with the standard benchmark which carries around 45 per cent in US Treasuries and 15 per cent in Japan. That kind of concentration carries risk, particularly as fiscal dynamics diverge across sovereign issuers.

 

The government bond universe is broader and more diversified than many investors appreciate. There are markets with improving credit profiles and attractive yields that rarely feature in domestic-focused allocations. In a world of rising political risk, fiscal pressure and reduced central bank support, diversification is not just a theoretical benefit but a genuine source of portfolio resilience.

 

The lesson of the past few years is that the assumed safe haven qualities of government bonds are no longer a given. But that does not mean the asset class has lost its role - it means investors need to be more deliberate about how they access it.

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Author

Irina Kurochkina, CFA
Portfolio Manager
Irina Kurochkina, CFA, is a portfolio manager with a focus on sovereigns.
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