Beyond Bulls & Bears

Fixed Income

European Fixed Income: Coming Out of Crisis

As European economies slowly start to come out of coronavirus lockdowns, it could be some time before growth returns to pre-crisis levels, according to David Zahn, our Head of European Fixed Income. He says the crisis has been another test for the European Union as the coronavirus has affected some countries moreso than others. But he sees this as perhaps the best time in years to invest in European fixed income.

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There’s no doubt COVID-19 has been devastating to the European economy, with gross domestic product (GDP) in the euro area contracting 3.8% in the first quarter in Europe.1 Given the period only included a couple weeks of shutdowns, we saw quite a big impact in a short period of time. We would anticipate GDP is likely to shrink further in the second quarter, but then hopefully we will see growth rebound a bit in the third and fourth quarters. For the year as a whole, we could see European GDP down 10% or more.2

Disparate Impacts, Disparate Needs

COVID-19 has impacted countries in Europe differently. As such, individual needs have differed, as have local government responses to the crisis. In our view, the European Union’s (EU’s) response so far has been weak; policymakers are still debating how much stimulus is needed and in what form, while individual countries have already taken actions. We are seeing almost a “Balkanisation” of Europe, in that some countries have dealt with the virus more effectively, have suffered less impact from it, and thus have been able to reopen their economies earlier than others. Italy and Spain are not allowing movement in and out of the country, for example, but Lithuania, Estonia and Latvia are allowing movement amongst them as a block. So, we will see certain country groupings where slow movement of trade and people is allowed.

Tourism is vital for many European economies, so a lack of travel during the summer season ahead is likely to have longer-term impacts on certain countries more than others. For example, travel and tourism represent roughly 15% of Spain’s GDP,3 so a prolonged drop off in travel is likely to negatively impact Spain more than some other countries.

There has been some fiscal stimulus to tide people over while they are at home, but in our view, additional stimulus will be needed as countries come out of lockdowns to get economies moving. We are seeing early signs of progress, but there’s also human psychology to deal with—what will make people feel safe to come back out of their homes, travel and spend?

It could take several years for the European economy to get back to the growth level prior to the pandemic, and there will be hiccups. Economies have never been stopped and then restarted on this type of scale.

Looking at the United Kingdom, policymakers on the fiscal and monetary side have come out with a strong support package—in that sense, we think they’ve taken the right actions to support the economy. On May 12, the UK government announced its furlough programme will be extended into October, so people out of work will have income coming in for a few more months.

In our view, the Bank of England (BoE) will probably announce more quantitative easing at its next meeting in June. The economic fallout in the United Kingdom has been similar to broader Europe, with GDP this year likely down about 10%, so we think the central bank will need to be ultra-accommodative and continue to buy bonds into the summer and beyond. As such, we think gilts will continue to perform well.

German Court Adds Wrinkle

The European Central Bank (ECB) has been ultra-accommodative—and with inflation not near its target, it can be. At the most recent policy meeting, the ECB announced new targeted longer-term refinancing operations (TLTRO III) at -1% and pandemic emergency longer-term refinancing operations (PELTROs) at -0.75 basis points,4 so bank funding is very inexpensive right now. The ECB also announced its €750 billion pandemic emergency quantitative easing programme of bond buying may need to be increased.

Meanwhile, we are seeing friction between one country—Germany—and pan-European institutions. The German constitutional court ruled on 5 May that the ECB’s 2015-2018 bond-buying programme didn’t respect “the principal of proportionality” and may have financed government deficits. While the ruling didn’t target the current program tied to the coronavirus, some observers say there could be implications down the road—it too could later be deemed illegal. It’s an interesting wrinkle that represents a test to the strength of the EU, pitting north against south.

Spain and Italy to the south were hit hardest by the coronavirus and have said they need more help. They support the issuance of “coronabonds,” a new debt instrument that would be backed by all countries in the eurozone to fund the crisis fallout. Meanwhile, Germany and the Netherlands are against the bonds.

There has been debate about a joint pandemic response plan as well. The northern countries generally favour loans that must be paid back, while the southern countries want grants. This type of disagreement harkens back to the 2011 sovereign crisis in Europe, which similarly pitted Italy and Spain against Germany and the Netherlands. The two sides of the eurozone are arguing again in terms of who should pay for the current crisis—and how.

What’s different today is that COVID-19 represents an external shock from a humanitarian event that is nobody’s fault. It seems like it should be fairly easy for the two sides to come together. If we don’t see EU countries come together with a solid, unified pandemic response, we are sowing the seeds for more distrust. There could be renewed noise about the future of Europe.

Given the poor outlook for economic growth and employment in the near term, in our view something will be needed to get the European economy restarted. There will be a European-wide assistance program coming, but slower than other individual countries. This easy money policy will be with us for several more years.

Brexit Issues Will Bubble Up Again

While Brexit headlines have taken a bit of a backseat to the coronavirus, there are still issues to be worked out—namely a trade deal. The United Kingdom has a deadline of 1 July to ask for an extension, but the UK government hasn’t asked for one. There is a template, but the EU countries want access to UK fishing waters, or they won’t do a deal. Both sides are digging in their heels, but neither side can afford a no-deal Brexit because neither the EU or UK economy is doing very well right now. We may see some brinkmanship but with trade currently reduced, maybe it doesn’t matter as much if there isn’t a trade deal.

Another interesting point is that the EU prohibits bilateral agreements between individual countries. However, with the coronavirus situation, we are seeing individual countries forming small travel and trade blocks, as noted previously.

If the United Kingdom does ask for an extension, that raises an interesting question: Would the United Kingdom be expected to contribute to a pandemic fund?

Looking at the Investment Landscape

In addition to UK gilts, we think the peripheral sovereign bond markets in Europe (Italy, Greece and Portugal) represent good opportunities for investors. It’s our view that the current friction within the EU actually offers an opportunity to solidify Europe. If it doesn’t happen now, it probably never will. We also believe investors should have long duration in Europe because growth will be so weak and inflation so low.

We also view investment-grade bonds in Europe as attractive right now. While yields had been very low for years, we currently see an opportunity for yield-seeking investors in the space, because there are quality European companies that will survive the crisis and do well over the long haul. As long-term investors, we think it’s a great time to be looking at bonds in Europe, whether sovereign bonds or corporate bonds.

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What Are the Risks?

All investments involve risks, including possible loss of principal.The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments.


1. Source: Eurostat preliminary flash GDP estimate, 30 April 2020.

2. There is no assurance any estimate, forecast or projection will be realised.

3. Source: World Travel and Tourism Council, 2018 data.

4. A basis point is a unit of measurement. One basis point is equal to 0.01%.

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