Believe it or not, Donald Trump’s return to the White House might just be good news for Europe’s fixed income markets. While U.S. investors brace for renewed protectionism and inflation risks, Europe’s debt landscape is showing signs of resilience—possibly even appeal.
AXA Investment Managers argues that European government bonds may be shaping up as a “safe haven” for fixed income investors, thanks to a stabilising ECB and structural reforms that have transformed the continent into a less fragile economic zone. But while optimism is high, there are those who say it’s too soon to celebrate.
Nick Hayes, AXA’s head of active fixed income allocation and total return, sees the market response leaning toward Europe, with government bond yields reflecting increased interest in European sovereigns. The 10-year German Bund—a touchstone for Europe’s government debt—dropped below 2.36 percent following initial confirmation of Trump’s re-election as US Treasury yields rose.
According to Hayes, Europe’s relative appeal is being enhanced by a European Central Bank that appears ready to cut rates if Trump’s trade policies weigh on the global economy. “The ECB might cut more aggressively in response to tariffs, while the Federal Reserve could hold back on easing,” he said.
In Thursday’s markets, the Bund yield was back up at 2.48 percent, reflecting perceived risk stemming from the collapse of Germany’s three-party government coalition. Still, the spread between 10-year bunds and Treasuries had widened to 200 basis points from 186 before Trump was re-elected, and from about 150 end of September, amid US inflation fears and expectations of further cuts in Euro rates.
Differing inflation outlook widens the Atlantic divide
This divergence positions European bonds as a safer, more stable choice just as U.S. inflation concerns start to mount, suggesting that global investors might pivot toward Europe to avoid the volatility plaguing U.S. Treasuries.
Europe’s structural strengths: Built to last?
Beyond rate cuts, Europe’s newfound resilience has become a talking point among market watchers. After a decade of structural reforms, Europe has evolved, with fewer economic imbalances and a proactive fiscal approach. Nicola Mai, economist and sovereign credit analyst at Pimco, believes these reforms have established Europe as a sturdier region. “Despite a weak growth outlook, the Euro area’s increased resilience and stability make European fixed income investments attractive,” Mai noted in a recent investor letter.
Indeed, Europe is now a net lender to the world, a noteworthy shift. With cross-border support through the EU Recovery Fund, fiscal policy has taken a cooperative turn that would have been unthinkable just a decade ago. Laura Cooper, global investment strategist at Nuveen, points out that European bond yields are responding to increased demand, reflecting a market view that sees Europe as a bastion of stability amid global turbulence. She expects the ECB to maintain steady rate cuts, projecting 25-basis-point reductions through March next year.
Schroders exercises caution
Not everyone is ready to embrace this narrative of a “safe” Europe, however. Michael Lake, fixed income investment director at Schroders, urges caution, highlighting risks that might chip away at the continent’s appeal. Lake is particularly wary of Trump’s protectionist tendencies, which could send shockwaves through Europe’s trade-reliant economy.
“An aggressive trade policy is anticipated to fuel concerns over the global trade cycle,” Lake cautioned in a comment to Investment Officer. Countries like Germany, with their heavy reliance on exports, may find themselves particularly vulnerable to the effects of new tariffs.
Lake also raises the spectre of currency risk, suggesting that a weaker euro, though potentially supportive of exports, may amplify economic strain if Europe’s growth outlook sours under a negative trade cycle. Furthermore, should European leaders choose to bolster autonomy through increased defence spending, that would likely mean issuing more sovereign debt—a move that could dampen the bond market’s appeal. While the political path toward such policies would be long, the implications are worth noting.
The currency conundrum: To hedge or not to hedge?
As Lake points out, currency fluctuations add another layer of complexity. For euro-based investors holding U.S. dollar assets, hedging decisions are increasingly pivotal. Hedging costs, which dropped earlier this year as the Fed cut rates, have climbed back in recent weeks, thanks to October’s currency volatility.
For investors who foresee a strong dollar, leaving exposures unhedged may be appealing; but for those less inclined to weather exchange rate swings, the rising cost of hedging is a factor that can’t be ignored. If the Fed moderates its rate cuts while the ECB continues on a more aggressive path, the cost to hedge could rise further, cutting into returns for those seeking to minimise currency risks.