In a context of global uncertainty, Europe faces a slowdown in its growth but will benefit from increased stability.
The economic prospects of Europe seem dull in the face of structural challenges, but institutional advances, increased coordination of policies and reinforced political cohesion nevertheless offer a stable framework to investors. With stable interest rates and a resilient credit market, the region offers attractive opportunities for those looking for diversification and reliable yields in an uncertain global landscape.
In our recent publication “Secular Outlook”, we have argued that a fragmented global economy combined with high levels of public debt will create a macroeconomic high voten votenth, with risks generally downward.
Europe is no exception. Internal and external challenges mean that Europe’s macroeconomic perspectives will remain modest, with slowing growth potential of approximately 1% before the pandemic at around 0.5% over the next five years. This slowdown is due to a lower demography and slower growth in productivity, according to our analysis. The low prospects of productivity reflect persistent challenges such as delay in the global technological race, intense competition from China, and higher energy prices than before the war in Ukraine, all aggravated by a less favorable global commercial environment (see also our recent note on UE-States trade relations).
The turn of the German fiscal policy towards higher expenses in defense and infrastructure is significant. However, we do not plan to extend to the whole region, because other major powers such as France, Italy and Spain are unlikely to increase their expenses that are not funded due to the constraints of debt sustainability. Additional expenses in defense outside Germany will probably be largely offset by cuts in other areas. Overall, we plan a globally neutral budgetary position in the euro zone over the next five years.
On the nominal level, inflation should not return to the level of 1% observed before the pandemic, taking into account demondialization pressures and slightly higher inflation expectations. However, we plan that inflation will stabilize below the target of the European Central Bank. The low prospects for growth and inflation will continue to anchor equilibrium interest rates, which should, in terms, fall back to the current nominal level of 2% suggested by our models.
Resilience through the region
As dark as it may seem, there is a glimmer of hope: we plan that the monetary union will remain stable in the long term. The region has passed significant resistance tests in recent years – including a pandemic and a war – demonstrating a strong political commitment to unity. This resilience has been supported by significant institutional progress, such as the ECB affirming its role as a lender in the last reliable resort for sovereign states (via various asset purchase programs and tools intended to manage tensions on sovereign debt), as well as better budgetary cooperation via cross -border tax transfers funded by the Next Generation program. Although Next Generation has been designed as a punctual measure, it offers a potential model in the event of future recession.
The current political landscape also seems less disruptive. Although populist pressures remain present, with far-right parties either in the government is increasing, the real euro-skepticism aimed at dismantling the EU and the monetary union has faded. For example, the risks received by the election of a far -right government in Italy quickly dissipated when the administration adopted moderate economic policies. Support for the euro is currently at record levels, and political commitment to cohesion could be more strengthened in a more conflictual global political environment.
That said, risks remain. We are closely monitoring France due to a debt trajectory compared to high increased GDP, difficulties in implementing budget cuts, and an already very high tax/GDP ratio. Nevertheless, a certain budgetary adjustment is ultimately likely, and we would consider this more as an idiosyncratic risk premium of France than an existential risk for the region.
Investment implications: rate and currency
The difficult growth prospects and the moderate inflation environment that we anticipate suggest that the valuations of European durations should remain stable, the bunds probably serving as a good diversifier in the wallets. In addition, increased demand for European European assets-stimulated by global diversification far from the United States-could further support these titles.
The theme of the steepest curves mentioned in the Pimco Secular Outlook also applies to Europe. The short and medium -term rates should remain anchored by low balance rates, while long -term yields will probably be supported by a higher German emission.
The stability of the monetary union should result in relatively stable sovereign differences compared to the BUNDs, allowing investors to obtain an additional return by buying a diversified basket of sovereign bonds of the euro zone. The line between central and peripheral countries also becomes more vague, so investors should choose the sovereigns according to the relative fundamentals rather than traditional classifications.
Regarding currencies, we do not see the role of the US dollar as a global reserve currency being called into question. However, global diversification could constitute a slight favorable wind for the euro.
Investment implications: Business Credit
In the high -quality investment grade credit grade credit segment, the European market of more than 4000 billion euros offers many opportunities to invest in transmitters having been tested on several economic cycles and used to evolving in a low growth environment. Given the moderate GDP growth in the region, many high -quality companies have generally adopted relatively conservative assessment strategies, providing sufficient financial flexibility to successfully navigate in various macroeconomic scenarios. Active management is essential to identify these specific opportunities.
The European market Investment Grade also benefits from the integrated diversification brought by duration, which, around five years, is centered on the area where we see the most attractive risk adjusted. In the world of global credit, the slightest sensitivity to interest rates of the European market has contributed to its lower volatility in recent years, positioning it advantageously in a context of more steep yield curves.
Apart from the Grade investment, the European high -performance bond market has improved considerably in quality in the past 15 years, with more than 65% of the market now rated BB. Over this period, the European high return offered yields comparable to those of the European equity market, but with a clearly lower volatility. While the valuations of actions continue to appreciate, the credit could again outperform in the long term, but with a volatility reduced by half to two thirds.
Finally, European credit could naturally benefit from the increase in the number of investors seeking to diversify outside of American credit, which is largely focused on American companies.