European Fixed Income in 2021: Focused on Recovery, and Politics

The calendar has turned to 2021, and while it looks similar to 2020 at the moment from a market perspective, there is hope on the horizon. We are still grappling with the ravages of COVID-19, but vaccinations are being administered across the globe and should help bring confidence—and economic growth—back later in the year. Europe will almost assuredly see a double-dip recession, but that is due to lockdowns that are still in place.

As such, the outlook for the eurozone is undoubtedly precarious in the near term. The bloc is beset with a new wave of COVID-19 infections, negative interest rates and disinflation. Although third-quarter 2020 gross domestic product figures showed a strong recovery, the prognosis is less optimistic for early 2021. As such, we believe the European Central Bank (ECB) will need to maintain its accommodative stance, with a continuation of low rates and further asset purchases to support the economy and markets.

As lockdowns are lifted, we should see an economic revival, but it could take two to three years to get back to where we were before the pandemic. Therefore, we expect to see continued ultra-accommodation from the central bank, and credit spreads will likely stay compressed. In the search for yield, we think many investors will look to central Europe and to lower credit quality.

We believe the actions of the European Union (EU) in 2020 will support the eurozone this year. The outlook for the region was bolstered considerably in late July when EU leaders finally reached an agreement on the €750 billion COVID-19 rescue plan. We think the approval of this package bodes well for the European economy, especially in the second half of the year as the funds are dispersed. This package should also demonstrate that the rules in Europe have changed with further integration— therefore reducing the risk premium demanded on European bonds—benefiting both government and corporate issues.

The EU will also be at the forefront of the climate-change agenda. Around 30% of the EU’s rescue plan and €1 trillion of its seven-year budget are earmarked for initiatives directed at fighting the detrimental impacts of climate change. We anticipate this will drive further investment and growth in the green bond market in Europe.

While we expect the economy to bounce back, the markets are likely to be volatile in the coming year. We currently believe it’s prudent to keep some cash at hand to deploy when opportunities arise.