Fixed Income Insights
Key Highlights:
- Germany’s EURO500 billion infrastructure fund and increased defence spending are projected to raise German GDP by 1per cent and Eurozone GDP by 0.4 per cent by 2026, catalysing a shift in investor sentiment
- European corporate credit markets remain resilient, with steady leverage levels and strong cash buffers, and with default rates expected to remain between 2 per cent and 3 per cent, despite external pressures and geopolitical uncertainties
- Sectoral opportunities emerge in banking, telecommunications and utilities, while caution is advised for the automotive and construction sectors due to heightened exposure to external risks, including US tariffs
How will increased defence spending and Germany’s fiscal boost impact the European economy?
Germany’s €500 billion infrastructure fund marks a significant departure from its traditionally austere fiscal stance. This fund, representing 12 per cent of Germany’s 2024 GDP, is expected to boost domestic demand and sentiment, potentially raising German GDP by 1 per cent and Eurozone GDP by 0.4 per cent by 2026. Increased defence spending across Europe, driven by reduced US military commitments and heightened security concerns, could boost economic growth further. However, the positive spillovers of military R&D into private-sector productivity may take time to materialise. Structural challenges such as low productivity growth, insufficient R&D investment and trade tensions remain critical hurdles for Europe. Mario Draghi’s blueprint for economic revival highlights the need for higher public and private investment, simplified regulations and increased market integration to address these issues and ensure long-term competitiveness.
How could this impact European credit markets?
European corporate credit markets are entering the current period of geopolitical uncertainty with robust fundamentals. Companies have maintained steady leverage levels, resilient profitability and strong cash buffers, with default rates expected to remain between 2 per cent and 3 per cent. The Euro credit market has grown significantly over the past decade, with enhanced sector diversity reducing systemic risks. Sectors such as banking, telecommunications and utilities are well positioned, supported by favourable policies and stable regulatory frameworks. However, vulnerable industries, such as the automotive and construction sectors, face external risks, including US tariffs and cyclical market trends. Spreads in European credit markets remain tight, calling for cautious positioning amid macroeconomic uncertainty. Nonetheless, elevated yields, alongside the resilience afforded by sector diversification, offer opportunities for investors seeking higher returns without sacrificing credit quality.