Payden & Rygel: Opportunities in European Fixed Income

Payden & Rygel: Opportunities in European Fixed Income

December 13, 2024

Fixed Income Europe
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In 2024, the growth divergence between the US and Europe has widened in favour of the US and we expect this trend to continue in 2025. Having said this, we think European fixed income markets offer interesting opportunities in both absolute terms and relative to other fixed income markets.

From a top-down perspective, the macro-outlook for the euro-area looks cloudier than the U.S.

  • Economic projections for the eurozone for next year remain sluggish with growth expected to be below trend and the growth gap with the US likely to increase.
  • The political backdrop has become less stable in the recent past with major economies like Germany and France facing the risk of political paralysis in the coming year.
  • In addition, the uncertainty around upcoming US trade policies and the threat of new tariffs towards Europe (and China) are yet another headwind for Europe and its external environment (which Europe is sensitive to).   

But this relatively weaker outlook doesn’t make us completely shy away from European fixed income markets. In fact, we think some areas of euro denominated fixed income markets offer good opportunities for European and international investors.

1.      The relatively weak growth outlook in Europe might prompt the European Central Bank to cut rates by more and faster than what investors currently expect and what the Fed does. Larger declines in bond yields would boost total returns.

2.      More accommodative financial conditions (and potentially looser lending standards) can be a strong tailwind to growth in the region given its reliance on short end rates and bank lending.

3.      Despite the weaker macro-outlook, credit fundamentals have remained fairly resilient in Europe. Easier financing conditions should help limit potential financial distress.

4.      Credit markets are already pricing in the weaker macro and political outlook in the region offering more attractive valuation levels (in absolute terms and relative to $ denominated markets). 

Granted, this relative cheapness is probably warranted given the higher level of risk in Europe and the credit spread between euro and US dollar denominated sectors could further widen from current levels. But in some instances, we feel the current spread advantage offers potential for incremental carry and a good cushion against further underperformance.

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