David Zahn at California-headquartered investment manager Franklin Templeton shares his insights on European growth and the fixed income market, highlighting how he is overweight in German and Spanish bonds, and discusses the political noise pervading France, Italy and the UK, as tension mounts on the Autumn budget.

Growth has been much more resilient than anticipated in Europe, according to David Zahn (pictured), head of European fixed income at Franklin Templeton. However, he thinks that the higher gas prices and higher interest rates will dampen growth, which will probably start to fade in the early part of next year.

“We do think growth will slow significantly and that the European Central Bank (ECB) will probably want to take back some of the interest rate hikes they have done,” Zahn told this news service in a recent interview.

“Our view on Europe and the UK is that too many interest rate hikes have been priced into the market. People are overestimating how much they will have to raise rates,” he continued. “This latest rise in yields, which has been quite significant, is going to put a dampener on growth and so therefore we are not going to say yields will drop quickly.”

“We have been mainly focusing on Germany in Europe, despite the fiscal spending they are doing. We are overweight in Germany and Spain, Poland and Romania,” Zahn said. “Most of it is Germany and Spain which seem to be the two most stable countries. Germany is the triple A asset in the world now and it has a stable profile for repayment and their growth is getting better at about 3 to 3.5 per cent. They are growing really well although they are spending a ton of money.”

His views are shared by Mauro Valle, head of fixed income at Generali Asset Management, which continues to think that German yields over 3.5 per cent are pricing in the current economic scenario and risks, justifying a constructive stance on duration.

Zahn is underweight in France and Italy. “There is a lot of political noise in France and next year in Italy when there are elections,” Zahn said. “On the French yields, it is interesting that we went through a spread of a 100 on France and I don’t expect them to go below 100 in the near future just because the politicial uncertainty remains quite high in France and that will remain at least probably until April/May depending on what the polls show. That will be an opportunity but not just yet.”

Zahn believes that if Marine Le Pen, France’s far-right National Rally party candidate, is elected next year, the impact may not be so bad. So far, she said she won’t be as dramatic as she has been in the past. Her lead in the second round of 2027 presidential elections widened this week. “Some of the far right parties have also learnt from what Italian Prime Minister Giorgia Meloni has done in Italy, being more market friendly. Meloni has done a really good job managing the markets,” Zahn added.

Nevertheless, Zahn is underweight in Italy, partly as Italy is going into an election next year. “It’s also almost a certainty that Meloni will ease the budget and increase spending next year. The budget deficit is slightly better but they still have a high debt stock and so for the longer dated bonds that’s quite important. Italian growth has been slow,” he added.   

Zahn also has some investments in Belgium, Luxembourg, and Iceland. “We have a little bit in UK, 10-year gilts and that’s worked relatively well as the UK has outperformed France and Italy but we are not huge on the UK,” Zahn said. “I think the UK has fiscal and political issues and once those are dealt with the UK bond market [will be] is actually quite interesting.”   

UK Autumn Budget
There is a lot of political noise in the UK, Zahn said. “It’s all about what the Autumn Budget is on October 28. This is building into a bigger and bigger event than probably what the government wants,” he said. “Market participants will be quite interested in this, specifically if the government increases taxes on various different areas or cuts the budget headroom or margin of money it keeps.”

“The biggest concern for me is cutting the headroom and that’s really just because, if anything, the last year or two has shown us is that the world is becoming much more volatile and financial markets are becoming more volatile and so, if anything, there should be greater headroom not less,” Zahn continued. “It would probably not be well received by the market if they were to cut headroom and also we are just waiting to see what the plan is. The new Prime Minister Andy Burnham has been in for almost three months and we haven’t really heard very much. He keeps saying it will be in the budget. They are putting a lot of pressure on October 28 so it will be quite interesting to see how that occurs.”

“Taxes have already been increased in the last two years so it wouldn’t shock me if they increase taxes again this year. It’s clear they want to tax more, spend more and use as much flexibility as they can. I don’t think the bond market will react positively to that. It won’t necessarily sell off a lot but I don’t think it will pay the premium the UK has to pay as there is a lot of fiscal and political uncertainty,” Zahn said.

Outlook
Nevertheless, Zahn said that bonds now pay a reasonable yield, so in the UK you can get 5 per cent and in Europe you can get 4 per cent quite easily. “Before equities gave a better return but now bonds are becoming something people are looking at. If you buy a bond and hold it to maturity you are pretty much guaranteed you will get what you bought,” he said. “I think it is something people are becoming more interested in. We are also still positive on green bonds. They have cheapened up. It is something that has an impact and you don’t have to pay for it. We have a significant number of green bonds in all of our portfolios.” 

For example, the Franklin Templeton green bond funds include the Franklin Global Green Bond Fund, the Franklin Sustainable Euro Green Bond UCITS ETF, the Franklin Sustainable Euro Green Corp 1-5 Year UCITS ETF, and the Franklin Sustainable Euro Green Sovereign UCITS ETF.