European bond markets: five musings from January

Jan 31, 2025

Neil Mehta, Portfolio Manager, provides the small pieces that make up the big picture in European macro and fixed income markets.

1. It seems investors can’t get enough of European government bonds (EGBs) at the moment. Demand in the primary market has been extremely resolute so far this year.

Big picture: heading into 2025, the EGB market faced several headwinds, not least the ~500bn+ EUR in expected net bond supply, but also the extra ~170bn in PEPP redemptions that need to be absorbed by the market as the ECB steps away from reinvesting maturing bonds.

Why it matters: it was an open question as to whether (more nimble) private investors would so readily take up the baton, but those fears seem overrated, for now. Even France, marred in political noise, managed to raise a 10bn EUR 15-year syndication for books running above 134bn.

2. Speaking of France, a headline in Bloomberg ‘French Bonds Draw Buyers with Budget Deal Finally in Sight’ caught my attention.

Zoom out: French 10-year OAT bond spreads are 30bps wider than one year ago after Macron’s knee-jerk snap election call and the political uncertainty that ensued.

Driving the news: the newly-appointed Bayrou government is expected to piece together a budget for 2025, and some investors are getting bullish again.

By the numbers: little political wiggle room means the budget deficit is projected to fall modestly this year to 5.4%, from 6% last year. Nominal GDP is running below 3% so closing this gap will be challenging. More salient is France’s record on fiscal forecasts, which let’s just say….isn’t great.

The bottom line: while the politics are a muddle – our thinking is to at least 2027 (next Presidential election) – French bond risk premia will remain elevated.

Source: @DanielKral1/X, Oxford Economics

3. Another winner in the EGB primary market this month was Greece, who are making a habit out of it, with a 4bn EUR issue 10x oversubscribed.

Zoom out: a return to IG status in 2023 and a PM recently lamenting ‘Germany must pull itself together’ exudes Greece’s newfound confidence among Europe’s power players.

Flashback: when we met Greek officials at the end of 2022, they were bemused that GGBs (Greece) were trading 50bps wider than similar maturity BTPs (Italy).

What they’re saying now: given Greece’s economic and fiscal trajectory, combined with the scarcity, the same officials told us there is no reason why GGBs shouldn’t be flat to PGBs (Portugal, some 40bps tighter).

The bottom line: that might be a bit ambitious given the large debt pile, but tighter France and even Spain is well within reach.

Source: @PatelisAlex/X, Eurostat

4. The ECB is quietly on autopilot to 2%.

Context: the main policy rate is 2.75% after last week’s announcement, and the market is expecting another cut in April before pricing for further cuts becomes more spread out in the summer and H2.

The big picture: the ECB council are in a good spot in terms of cohesion, and the doves seem in control with many members in broad agreement that getting rates to neutral is a good plan. Moreover, wages are falling and the latest ECB lending survey points towards further credit tightening.

Reality check: we have largely seen the market price out the idea of cuts being front-loaded in, but the data and ECB-speak continue to point towards getting to a ‘neutral’ policy stance in earnest.

Opinion: we think neutral policy rate is between 1.75-2.25%.

Source: ECB, as at January 2025

5. January can’t go without a comment on the UK, which was a pressing topic of conversation at a recent dinner with macro investors.

The big picture: gilt yields and GBP swap spreads have had a volatile start to the year on renewed inflation and growth concerns spilling over into a deteriorating fiscal profile, leaving the UK government with some tough choices regarding taxation and borrowing.

Flashback: the market rightly paranoid about anything UK-related after Autumn 2022, adding to sensitivity and risk premia.

Between the lines: the Labour government puts a lot of emphasis on sticking to its self-imposed fiscal rules (after relaxing them) in deliberate contrast to previous governments. Markets are therefore also putting more scrutiny on these rules as a harbinger for government credibility.

What’s next: a turnaround will need a big chunk of luck, partially on domestic inflation and global spillovers.

Opinion: a period away from the headlines might just give UK assets a short-term reprieve.

Source: British Chamber of Commerce

All date sourced from Bloomberg, as at January 2025.

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