Rethinking European Fixed Income: Navigating Policy, Risk and Opportunity
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With the global economy at a crossroads, is it time for investors to rethink fixed income?
This question and many others were explored in our recent webinar with experts from the Amundi Investment Institute — Anna Rosenberg, Head of Geopolitics, and Valentine Ainouz, Global Head of Global Fixed Income Strategy — and special guest Peter Praet, former Chief Economist and Executive Board Member of the European Central Bank.
Former ECB Chief Economist
Peter Praet
Anna discussed today’s complex geopolitical landscape: Europe faces rising risks from multipolar global competition, economic protectionism, and ongoing tensions such as the US-China rivalry and the Russia-Ukraine conflict.
On the economic front, Valentine examined how rising government funding needs and persistent supply shocks are driving higher term premiums in fixed income markets, while moderate Eurozone growth depends on boosting investment, productivity, and managing long-term yields effectively.
This summary focuses on Peter Praet’s discussion points during the webinar, where he shared deep insights into the intersection of geopolitical risks, government debt trajectories, and central bank policy.
Below are the key takeaways from Peter Praet’s perspective during the session, interviewed by Olivier Genin, Deputy Head of Market & Product Strategies and Head of Fixed Income, Amundi ETF & Indexing:
Olivier Genin (O.G.): Peter, it is an honour to have you as our guest today and to benefit from your insights and experience. Firstly, there has been a significant change in the geopolitical and economic landscape since COVID 19. In your view, what most clearly defines this new environment?
Peter Praet (P.P.): High uncertainty is the name of the game.
Markets view the US as one major source of uncertainty, but many assume that “US policy uncertainty” is largely tactical, intended to extract maximum gains and that at the end of the day it will not be too market unfriendly. Current market prices seem to reflect this view.
There is a more negative interpretation, which I share. This is that we experience a regime change, a world of more frequent and persistent negative supply shocks, which put downward pressures on potential growth, and upside pressures on prices.
A second point is the difficult situation of public finances in most countries of the world, but in particular in the US, the issuer of the world safe asset ‘par excellence’. Traditionally, under high uncertainty there is strong demand for US Treasuries. But in the current environment of unsustainable US public finances, we have seen worrisome signs of tension. Some consider gold as a “safer” choice, diversifying out of the dollar. There's a big question mark about what a ‘safe asset’ is today.
A third point is that the private sector remains surprisingly resilient, given the circumstances. One explanation is that the balance sheets of households, firms and banks appear much sounder than they were before COVID. Of course, the private sector was relatively well protected during COVID, but at the cost of public finances. Therefore, the question: can private sector balance-sheets remain strong in a context of high stress in public finances? Spill-overs across balance-sheets might be unavoidable at some stage.
O.G.: Given this highly uncertain environment with repeated supply shocks and elevated government funding needs, what is the ECB’s strategy?
P.P.: Supply shocks are a dilemma for the central bank.
The stronger your credibility, the more you can be patient. The problem is that we had an inflationary shock after COVID and, while the ECB acted forcefully and regained credibility, it is still in the mindset that it must act forcefully if there is a new price shock. It does not want to allow inflation expectations to become de-anchored.
If there is a new and significant shock on prices, it will not necessarily look through it and be patient.
I think most Governing Council members today are comfortable with 2% interest rates, and they are not going to rush to cut further in the absence of a significant deterioration of labour market conditions.
The other thing to mention is that the ECB talked in its recent strategy review about its toolbox, the instruments it could use if there is a new shock and bond markets become disorderly. For example, if the root cause lies in a common shock that affects some countries more heavily than others. I think it's particularly important for investors that the ECB is saying that, it remains ready to intervene to ensure orderly market conditions in such case.
O.G.: Turning towards the economic problems in Europe, it’s clear that increased investments in areas like defence could be one way to boost growth. However, countries have different capacities to employ more expansionary fiscal policies.
What could be the policy responses to the risks of economic fragmentation, and how much monetary and fiscal policy space is available?
P.P.: We don't have much monetary policy space left in interest rates. Cutting rates from 2% to zero doesn't make a huge difference. I think most members of the Governing Council do not believe that it would really change the outlook in the context of high geopolitical uncertainty. Also there is currently not much appetite and need to re-use non-conventional instruments. A significant appreciation of the euro may, however, lead the ECB to reconsider the rate path.
With fiscal policy, there is not much you can do. Germany is using the space it has, which is positive. But the problem of Europe is not lack of fiscal space. There are a lot of policy measures that are not fiscal measures, like deregulation, promoting a more business friendly climate, which countries should focus on.
The problem of structural reforms is that there are a lot of internal political issues. In most countries governments are weak, making reforms difficult to implement. In the US, the government is strong…but the policies they are following are unsustainable.
Before the Global Financial Crisis, there was too much certainty. One was talking about ‘the end of the business cycle’. Too much certainty led to too much risk taking. It ended in a terrible financial crisis. Now we're in the opposite situation with high uncertainty leading to high savings rates, postponement of investment decisions waiting for more ‘geopolitical’ clarity. Governments have a critical role to play. It is imperative that they implement a long-overdue reform agenda.
The problem in Europe is that it takes time to take decisions. But under severe stress, conditions are now better to speed up the reform agenda. That explains why markets are so interested in Europe.
O.G.: Thank you Peter for sharing your insights, it was a privilege to discuss these important issues with you.
The views expressed in this interview are the views of the interviewee and do not represent the opinion of Amundi ETF.
Identifying opportunities amid uncertainty with Amundi ETF
At Amundi, we believe that despite the pervading uncertainty, the current European fixed income environment still presents some interesting opportunities.
One example is longer-dated government bonds. These typically perform well when interest rates are falling,1 and yields are still elevated relative to recent years — providing both income potential and room for capital gains.1 Given ongoing global risks, including trade tensions and weakening growth, demand for perceived safe-haven assets could also continue to support government bond prices.
In addition, investment-grade credit, in our view, remains attractive, as fundamentals remain sound.1 Since we do not anticipate a recession — only prolonged low growth — this segment may offer appealing valuations.2 Now may be a good time for investors to lock in yields before they decline further.2
1.Past market trends are not a reliable indicator of future ones.
2.Investment involves risks. For more information, please refer to the Risk section below.
Accessing the opportunity
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