In a year of elections, European bonds still seem a safer bet than US debt

The writer is chief market strategist for Europe, Middle East and Africa at JPMorgan Asset Management

As voters in the west decide who they want in government, bond investors must also choose which of these governments’ debts they are willing to hold. And whether they should be demanding any additional premium for risks around policy over the longer term.

In the EU, the weekend’s elections showed an even greater shift to the right than had been anticipated. The result was so significant in France that President Emmanuel Macron called a national election. 

For investors still haunted by the 2011-12 sovereign debt crisis, any electoral upset in Europe is a little disconcerting. But it is important to put this in perspective. Crucially, right-leaning parties that have gained support have not been advocating EU break-up.

The common thread among the right-leaning parties is discontent about immigration and climate policies that are seen to be hurting domestic industry. The French electorate is likely also wooed by Marine Le Pen’s opposition to steadily increasing the retirement age. 

Bond investors are therefore understandably questioning France’s fiscal direction and pushing French government bond yields higher. But the case for the market to be pushing yields higher in the likes of Spain and Italy is weaker.

And in general, I am more positive on the outlook for European bonds than US Treasuries as we turn towards the US election in November. While there is still a lot to learn about prospective policies, Joe Biden’s and Donald Trump’s campaigns both centre on America-first policies, including curbing migration and raising tariffs on imports from abroad to promote reshoring, ie American jobs for American people.

The problem is that it doesn’t look like there are many American people looking for work. The unemployment rate is at a record low. The US economy has only been able to accommodate surging post-pandemic demand thanks to massive migration. Without the 3.7mn additional migrant workers added since 2020, the US would most likely have had even higher inflation and interest rates.

These policies, therefore, run the risk of potentially restoking inflation concerns. The market has already had to considerably scale back its expectations for lower interest rates from the US Federal Reserve this year, as inflation has proven to be sticky. If demand is resilient, widespread tariffs and curbs on migration could reignite the debate about whether the next move for policy rates is actually up.

But it’s not so much the short-term policies that are making me more wary of US Treasuries. Instead, it’s the broader discussion — or more specifically, lack of discussion — about escalating US debt levels and their trajectory. 

The US is running a 6 per cent fiscal deficit. This level would be understandable in a period of temporary economic weakness. But the US economy has been booming. Roughly half of this deficit is due to the fact that the US government, like governments elsewhere, now has to pay a lot more interest on its existing debt. The factors that had been depressing global demand and interest rates — like private sector deleveraging and quantitative easing — are unlikely to return and save the day. 

The other half of the deficit is a structural shortfall, where government receipts fall short of spending, largely due to the tax cuts initiated by Trump as president. He has said that he plans to extend these tax cuts. Based on the US Congressional Budget Office’s latest estimates, this would see the budget deficit rise to 7 per cent of GDP and the level of debt to GDP rise to 124 per cent in the coming decade. And that assumes the economy is running well in the background. A recession, financial bailout, or other unforeseen shock would throw that number even further off course.

Could a US president face a bond crisis in the way former UK prime minister Liz Truss did? The US’s status as the world’s reserve currency suggests perhaps not. Many investors must buy US Treasuries for the purposes of trade or managing a currency. But could the US be starting to push that privilege too far? What level of debt is too much? No one knows. What I do know is the risks are rising and term premium — the compensation paid for these risks — does not look high enough. It goes without saying that any doubts could challenge the dollar as much as the Treasury market.

And government bond markets elsewhere won’t be immune to volatility in the US market. That said, I’m still inclined to seek protection in the European government bond markets where the lessons of fiscal largesse have been well learned.