Navigating Europe's Bond Market: Risk, Reward, and Resurgence

Uncertainty. If there is one thing that bond investors hate, it is uncertainty. After all, fixed income investors tend to be a conservative lot, trading into risks for steady coupon payments and repayment of principal. And right now, there is a ton of uncertainty in Europe. From geopolitical woes and tariffs to rising spending and high deficits, European bonds don’t actually appear very safe.

But if history is any guide, investors have a big opportunity.

With high yields and still strong fiscal attributes, European bonds may be priced incorrectly. That could be seen as a great chance to boost a portfolio’s income while potentially generating some very strong capital gains. For investors, there’s certainly a place for European bonds in your portfolio.

A Wall of Worry

U.S. investors are underweight Europe’s bond market, often owning zero sovereigns issued by European governments, the European Union, and various government agencies. On the surface, that seems like the right call. The region has an abundance of uncertainty lately.

For starters, global growth concerns are starting to make their way back into the equation. This has been exacerbated by the looming Trump Administration tariffs. Europe faces tariffs of 10% to 20% on various exports. The sectors that have been targeted—automobiles, heavy industrial machinery, chemicals, pharmaceuticals, and food—happen to be the largest exports out of the region. Adding to the issue remains the tariffs placed upon China. European manufacturers will now have additional competition with displaced Chinese goods that were once bound for the U.S. market.

On the back of economic uncertainty comes a high dose of political uncertainty as well. Many European governments have started to face voter backlashes over high energy prices. Election issues in France and Germany have added to policy questions and instability.

At the same time, spending in many European nations continues to rise. To meet aggressive green transitions and climate accord measures, European nations are expected to spend roughly 2.5% of GDP on renewable measures. Meanwhile, President Trump’s stoppage of NATO spending will require many nations to spend 3% of GDP on defense, up from just under 1%.

All of this has put pressure on European bonds, particularly in recent weeks, as Germany has enacted a ‘whatever it takes’ approach to keeping its economy humming along amid the uncertainty. Yields have begun to rise as investors have sold a wide variety of sovereigns and European debt.

A Break in the Clouds

And yet, amid all the uncertainty and cloudiness among European bonds, there are some sun spots peaking through.

For one thing, yields are at a great starting point. Since the U.S. Presidential election, yields in Europe have remained elevated, which makes sense considering investors are getting concerned. This chart from the Financial Times shows the current spike in both German and French bonds. There’s a similar pattern to other nations within Europe, such as Italy, Spain, and even the European Central Bank (ECB) bonds.

Source: FT.com

However, according to AllianceBernstein (AB), a higher starting yield has historically been a great place for long-term returns in a wide variety of economic conditions. Looking at starting bond yields via yield-to-worst and the next five years forward returns, the asset manager found a strong positive correlation. Simply put, when yields are high—as they are now—investors receive great returns regardless of economic risks. AB’s data set includes such events as the Tech Bubble, European Debt Crisis, and Oil Price Inflation of 2016. ¹

And there’s reason to believe that European bonds will see similar strong results this time around.

That’s because the ECB and various central banks in the region have started to cut interest rates and haven’t paused like the Fed here at home. Back at its December 2024 meeting, the ECB Governing Council announced that it was done with restrictive monetary policy and essentially greenlit rate cuts at each subsequent meeting until June 2025. The market now expects the ECB’s policy rate to settle at 2.0% to 2.25% over the next few years. This is bullish for bond prices as investors look to lock in higher yields in longer bonds amid rate cuts.

This should help European bonds produce a strong total return of a high coupon and a capital gain for investors willing to take the plunge today.

Gaining Access to Europe’s Bond Market

Now, there are the risks highlighted at the beginning of this article to consider. But investors may want to consider adding European bonds to their portfolios. With the ECB and other European central banks preparing to cut rates amid economic slowdowns and tariffs, prices of bonds will rise, providing a strong total return effect for portfolios with the current high yields. There’s plenty of historical precedent for that.

Getting exposure directly isn’t hard for many investors, but it does come with some headaches. Any good brokerage platform will let you buy ECB bonds, U.K. Gilts, and other Eurobonds just as you would a bond from Walmart or Uncle Sam. However, that may not be in their best interest. Bid/ask spreads tend to be wide for even heavily traded European bonds. At the same time, investors will need to hold euros or other currencies to make the transaction and pay additional fees for the currency transactions. That may not make the extra yield worth it.

What is worth it? Using an ETF. There isn’t a direct European bond ETF on the market today. Nonetheless, Eurobonds dominate many of the largest international bond ETFs. By using these, investors can have a similar effect and still gain much of their benefits, including the chance for price increases and good current yield.

International Bond ETFs

These funds were selected based on their exposure to international bonds with a hefty focus on European-issued securities. They are sorted by their YTD total return, which ranges from 2.2% to 4.3%. They have expense ratios between 0.35% to 0.50% and assets under management between $77M to $970M. They are currently yielding between 0.6% and 2.5%.

Overall, European bonds offer a real chance at a good total return. With high starting yields and various European central banks starting to cut rates to shore up growth, investors have the opportunity for some strong total returns. Adding exposure is easy when done through an international bond ETF.

The Bottom Line

European bond yields have been rising amid uncertainty, tariffs, and huge spending plans. For investors, this could be a great moment to strike. With rate cuts ahead to help ward off slowing growth, portfolios have the ability to get strong total returns.

¹ AB (January 2025). European Fixed-Income Outlook 2025: Adversity, Uncertainty, Opportunity