Macro Talking Points - Week of 10 March 2025

In brief

• A game changer for Germany and the eurozone
• The case for long duration in Europe is now more complicated
• Euro credit valuation looks attractive through a long-term lens
• Volatility episodes feel painful but tend to be brief and not too numerous

Exactly what the Doktor ordered. Germany produced a major surprise last week with what our DM sovereign research team described as a “fiscal bazooka,” an ambitious plan to boost government spending and lift deficit limits. This was a welcome development not only for Germany but also for Europe. It aims to address two fundamental problems: first, the need for Europe, in the context of a more complicated geopolitical landscape, to catch up with its defense spending and second, boosting Germany’s public investment following years of fiscal austerity. A strong fiscal program appears to be the right policy response, so this can be viewed as a risk-on signal for risky assets in Europe. Don’t underestimate this development: It may be a game changer for global markets. It is certainly a game changer for global rates, global currencies and global asset allocation, with the latter benefiting Europe. At this juncture, it is possible that the strong dollar environment that had prevailed for a while may face a serious challenge. Suddenly, European assets, including European fixed income, look a lot more attractive, helped by a rejuvenated euro, which had looked like the sick currency of Europe for some time but is responding to the fiscal steroid injection. Meanwhile, euro credit spreads are showing downside momentum, driven by the positive repricing of European growth and a strong technical backdrop. My colleague Mike Dembro from Client Strategy couldn’t have said it better: Global investors are having major Europe FOMO.

Goldilocks has left the chat. Until recently, Market Insights believed that while the US had already moved away from a Goldilocks macro regime, at least the eurozone was enjoying a Goldilocks fixed income backdrop, with rates set to move lower. That’s no longer the case. Following the big fiscal signal coming from Germany, our investment team has had to revisit its core view on European duration. Indeed, the sharp repricing of long-end European rates has warranted turning more cautious on duration in Europe. To be clear, the upward move in bund yields has been nothing short of spectacular: The 40-basis-point rise in 10-year bund yields over the past week was the largest move since February 1990, and for the statisticians among us, it has been a 3.9-sigma event,¹ which supposed to happen only once every 125 years. In addition, the ECB changed its tone, which caused the market to price out some future rate cuts. Keeping that in mind, while the market environment has turned more supportive of risky assets in the eurozone, investors will likely be less able to count on a significant drop in market rates to help drive European fixed income total returns. The good news is that euro credit remains well positioned, supported by strong fundamentals and solid technicals. If anything, the yield valuation for euro credit has improved dramatically, with yields now standing at 3.4%.² More on that below.

The strategic power of entry points for Euro credit. Entry points matter for long-term fixed income expected returns. Given the current attractive level of European investment-grade yields, the outlook for expected returns has improved considerably. This is because there has historically been a strong relationship between starting yields like today’s and robust future returns. For instance, at a starting yield of 3.4% for European IG, the median annualized return for the subsequent five years — using a 30-basis-point range around the starting yield — stands at 4.40%, an attractive hypothetical return with a return range of 3.09% to 5.88%.³ By comparison, the 20-year annualized return for European IG stands at 2.72%, suggesting that at current yields, the asset class is well positioned to potentially deliver higher-than-average returns over the next few years.⁴

Market volatility watch. There’s some good news and some bad news here. Starting with the bad news: Equity volatility has been on the rise since mid-February, with the VIX now standing at 26.33.⁵ Technically, it probably doesn’t meet the definition of elevated just yet — using the criterion of a 1-sigma move from the longterm average — but we may get there soon. If the VIX crosses 28.8, that will meet our technical definition. Now the good news: Previous episodes of elevated volatility have historically been brief and not too numerous. Since January 2000, there have been 742 days of elevated volatility, or only 11% of the total number of trading days. In addition, since 2000, episodes of elevated volatility have lasted 6.8 days on average, and that includes during the global financial crisis, which alone produced a 171-day stint. Excluding the GFC, the average episode lasted 5.3 days. Granted, five days can feel like a long time when markets are experiencing severe turbulence, but it’s fair to say we’re not talking about a prolonged shock, outside of recessions. Away from equities, the moves in fixed income have been subdued, even when considering high yield. US HY spreads have widened by 35 bps over the past month, which doesn’t represent a big slide by historical standards. Overall, fixed income remains well positioned as an attractive defensive asset class in the face of ongoing volatility and market uncertainty.

Endnotes:

^₁ Source: Bloomberg. Bund = Bloomberg 10yr Bund generic yields. Data as of 7 March 2025. One sigma = one unit of standard deviation.
^₂ Source: Bloomberg. Euro credit = Bloomberg pan-European corporate credit index. Data as of 7 March 2025.
^₃ Source: Bloomberg. Euro credit = Bloomberg pan-European corporate credit index. Data as of 7 March 2025.
^₄ Source: Bloomberg. Euro credit = Bloomberg pan-European corporate credit index. Total return in gross in EUR. 20-year return calculated between March 2005/ March 2025 (as of 7 March).
^₅ Source: Bloomberg Chicago Board Options Exchange. VIX = The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500^® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes. Data as of 7 March 2025.

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