Capital IdeasTM

Investment insights from Capital Group

Fixed Income
European market outlook: Clouds on the horizon
Elaine Lin
Investment Analyst

After a decade of ultra-loose monetary policy, we are starting to see the intended and unintended consequences of one of the most aggressive periods of monetary policy tightening in history.

As intended, consumer demand is weakening, and lending standards are becoming more restrictive. However, the aggressive tightening of monetary policy is also testing the financial system and the collapse of SVB and Credit Suisse are the unintended consequences.

According to investment analyst Elaine Lin, these recent events have meaningfully increased the likelihood of a recession. Even though central banks and regulators have been quick to act and are standing ready to shield the financial system from another 'Lehman moment’, it is important to note that the economy doesn’t need another global financial crisis to enter a recession.

The European Central Bank (ECB), whose only formal mandate is to maintain inflation at 2% still needs to contend with elevated inflation. The latest data shows eurozone core inflation at its highest level on record. Therefore, despite the recent market volatility, the ECB went ahead and delivered a pre-committed 50bps at its March meeting. However, it has abandoned its forward guidance and is now completely focused on data dependency.

This, according to Lin, is probably the right approach as they no longer have clear insight into how the economy will now unfold. This also likely implies a lower terminal rate as economic data deteriorates further.

Given this backdrop and the rising probability of a eurozone recession, Lin believes there is now in my view more value in Bunds. She has added euro duration to capture some of this value and remains underweight sovereign spreads in countries like Italy. 

Elaine Lin is a fixed income investment analyst at Capital Group with research responsibility for Western Europe sovereign debt markets. She has 15 years of investment industry experience and has been with Capital Group for three years. She holds a master's in economics from London School of Economics and a bachelor's degree in accounting & economics from Southampton University. Elaine is based in London

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