Slow Growth in Europe Good for Bond Investors

The European Central Bank has taken action to help kickstart the eurozone economy - but will these measures be enough and what effect will stimulus have on bond yields?

Emma Wall 15 October, 2014 | 10:59AM
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Emma Wall: Hello and welcome to the Morningstar series 'Why Should I Invest With You?' I'm Emma Wall and here with me today is David Zahn, Manager of the Franklin Strategic Bond Fund. Hello David.

David Zahn: Hello.

Wall: So as well as running a strategic bond fund and several other fixed income portfolios you are also Head of European Fixed Income for Franklin. So I thought today we could talk about what's going on in Europe. There's been some measures over the summer which hoped to kick start growth, do you think that will be effective?

Zahn: Well, I think the ECB has done many different things to attempt to stimulate the economy through the TLTROs or the asset backed purchase programme we are going to have soon. But I don’t think any one of these measures would be enough. I think it will be a combination of these measures. And I do – I think it's really how much uptake they get from the banks and if they get enough uptake it could move the needle slightly. But I really do think that we are moving closer and closer to outright quantitative easing probably next year.

Wall: And how will that work with a single currency landmass such as Europe?

Zahn: Well I think the exact dynamics will be interesting to see how those play out. But I do think that they need to have a large asset class that they can purchase and so I think it will be government bonds to some degree.

I know there is a lot of conflict of whether or not this is allowed or not, but I do think that they will get to that point where this is the only way. Inflation is too low in Europe, we are running at 0.3% well below their 2% inflation target and they need to do something. Not necessarily get the growth going dramatically, but just keep inflation from getting too low.

Wall: It's a measure that has been so effective in the US and in the UK. Europe, and indeed the Bank of Japan, have resisted doing it, and now it seems that Europe is going to have to.

Zahn: Well I think that’s absolutely correct we've seen the US is going to stop their QE this month. Bank of Japan continues their QE and the EU is going to have to start their QE sooner or later I believe. And I do think that this also has to be in combination with a fiscal programme which we won't see out of Europe because they are trying to get their fiscal house in order, but I do think there are some more core countries that can probably do something more in a fiscal programme than what they are currently doing.

Wall: Getting down to the nitty-gritty then, you've explained how it will help to boost the economy, what would it mean for investors and in particular bond investors?

Zahn: I think Europe is quite exciting place for bond investors, because if you look at what's going on in Europe, we have slow to no growth. We have low inflation or almost zero inflation and you have a central bank that’s being very accommodative.

So I think this means that central bank will not be raising rates for many, many years and I think that means that bond yields can actually stay at relative low level or maybe even go slightly lower from here. And that’s why we like peripheral bonds Spain, Italy, because they actually may see further convergence on the Germany as you see more liquidity coming into the system.

Wall: And of course bond yields going down mean bond prices going up.

Zahn: Price is going up, yeah, absolutely. So I think this is one of the bond markets in the world that it will be relatively anchored or stable and you could see price appreciation where I think in the U.K. you probably will see yields going up prices going down as the central banks starts to move and same in the U.S.

So I think it is an area where investors can find bond returns and some yields that have a little bit more stability than other places in the world.

Wall: David, thank you very much.

Zahn: Thank you very much.

Wall: This is Emma Wall from Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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