The outlook for European fixed income

This article is part of
Guide to investing in Europe

Where next?

Fixed income investors may be wondering where yield curves can be expected to go now that the ECB has confirmed the trajectory of monetary policy.

Kommer van Trigt, head of global fixed income macro at Robeco, forecasts: “We expect this combination of gradual tightening and modest inflation to lead to a flattening of yield curves, tightening of euro periphery spreads and a compression of the spread between US Treasuries and Bunds. The investment grade credit market continues to perform well. 

“With the ECB’s policy extended well into 2018, the technical support for at least the European bond market remains in place.”

Fears among advisers and their clients that the bond bull market run is over seem to be unfounded, for now.

But investors allocating to European fixed income need to bear in mind the economic and fiscal backdrop as they are doing so.

David Stubbs, head of client investment strategy for EMEA at JP Morgan Private Bank, suggests a fixed income allocation that benefits from Europe’s economic growth revival, increase in financial lending and accommodative central bank monetary policies is a compelling option for investors. 

“Yet current yields suggest traditional fixed income investments do not offer the risk-reward trade-off they did in the past, and there is a requirement to consider other ideas,” he points out.

“One of the opportunities we have identified outside of the core eurozone involves investing in fixed income securities denominated in Turkish lira."

Double-digit yields are available on short maturities of only a couple of years, with bonds issued by supranational agencies of particular interest, Mr Stubbs explains. 

“Naturally such an investment involves exchange rate risk. However, while it is far from certain that the Turkish lira will strengthen materially, the era of rapid depreciation appears to have ended.”

Currency hedging is a strategy also proposed by Brewin Dolphin’s head of research Guy Foster.

“Bond yields are clearly very low in Europe and while we found the single currency compelling earlier in the year we now feel the value has eroded. 

“Enhancing yields through currency hedging is therefore attractive, particularly after the recent UK interest rate rise but duration risk remains elevated and poorly compensated,” he comments.

Shake it off

For Mr Iggo, the fixed income environment in Europe is conducive to generally positive returns.

“Even with rates, the likely increases are going to be modest in the short-term given the ongoing, albeit smaller, expansion of central bank balance sheets at the global level.”