In 2025, European short-term deposits, valued at hundreds of billions of euros, are expected to mature. Yet, with the European Central Bank’s (ECB) ongoing monetary easing, the returns on cash deposits are becoming increasingly unattractive. Between June 2024 and January 2025, the ECB made five interest rate cuts, signalling a cooling of euro-area inflation. Further cuts are anticipated throughout 2025 as the ECB seeks to revitalize the sluggish eurozone economy, with the deposit rate predicted to fall to 2%.

The Challenge of Low-Yield Cash Deposits

For conservative investors seeking safe returns on surplus liquidity, negative real yields on cash deposits (i.e adjusted for inflation) may soon become a reality, a shift unseen since 2022. This situation pushes investors toward alternative low-risk fixed-income markets to activate their cash by embracing new opportunities with greater potential to offset inflation without disrupting their risk profile.

While government bonds could serve as a potential option due to their safety features, only considering this segment of the safe fixed income space is not ideal. Indeed they currently face pressure from rising EU member-state debt due to persistent budget deficits, which may affect their performance and result in important losses as witnessed in since the beginning of 2025.

Other safe fixed income instruments may offer the same safety than government bonds: Covered bonds. For those not familiar with this asset class, covered bonds are fixed-income securities issued by banks or mortgage lenders and secured by a pool of assets, such as residential mortgages or public-sector loans. These bonds provide investors with two layers of protection: recourse to the issuer’s assets and access to the cover asset pool, which is typically over-collateralized. This dual protection helps explain the fact that, in the 200 years since the first covered bonds were issued, there has not been a single instance of default.¹

This is where a more dynamic allocation to a broader universe high-quality fixed-income securities, including government bonds and covered bonds, could come into play.

This could allow the investor to exploit opportunities wherever they appear and generate more consistent returns potential over time with a more diversified allocation. Also safe fixed income markets are inefficient and as a result, in our view, skilful active management can add value.

Unfortunately, that might not be enough for investors looking for capital preservation or low risk, as high quality bonds are very often much exposed to changes in interest rates. That’s why it’s of utmost importance to be able to build a strategy not reliant on predictions about where yields might evolve, but rather to build a strategy with a limited exposure to interest rate risk with potential to perform in various market environments. While that may sound impossible, experienced and active investors would seek to exploit inefficiencies and generate consistent alpha on top of cash.

All in all conservative investors are not doomed to stay with unattractive cash deposits yield. Exploiting opportunities in the safe fixed income space, because of their safety, and adopting a dynamic approach might be a smart alternative to activate their cash. Finally, controlling your exposure to interest rate risk will help to generate consistent returns regardless of the macroeconomic environment.

In conclusion, while the low-yield environment in European short-term deposits presents a challenge for conservative investors, it also opens the door to more dynamic and potentially rewarding investment strategies. By diversifying into high-quality fixed-income instruments such as government bonds and covered bonds, investors can benefit from greater protection and stability, while actively managing risks and opportunities in a shifting macroeconomic landscape. We believe the key to success lies in controlling exposure to interest rate risk and implementing a strategy that remains flexible to evolving market conditions. Ultimately, through a thoughtful and active approach, investors can move beyond the constraints of unattractive cash deposit yields and pursue consistent, long-term return potential in the fixed-income space.

Disclaimer:

Covered bond risk: usually issued by financial institutions, backed by a pool of assets (typically, but not exclusively, mortgages and public sector debt) that secure or “cover” the bond if the issuer becomes insolvent. With covered bonds the assets being used as collateral remain on the issuer’s balance sheet, giving bondholders additional recourse against the issuer in case of default. In addition to carrying credit, default and interest rate risks, covered bonds could face the risk that the collateral set aside to secure bond principal could decline in value.

The value of your investment can go up and down, and you could lose some or all of your invested money.