From Cycles to Structure: Europe’s Investment Story

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Welcome to Fixing Your Interest. Joining us are three members of PIMCO’s European Portfolio Committee. Together, they’ll unpack the ECB’s policy stance, Europe’s structural challenges, political dynamics, and the investment implications across sovereign and corporate credit.

Nicola Mai, Economist and Sovereign Credit Analyst, brings two decades of experience shaping macro views and credit strategy. Konstantin Veit, Portfolio Manager, leads PIMCO’s European rates and short-term desks, with expertise in monetary policy and market structure. Sara Adjir, Portfolio Manager, offers sharp insights into macro trends and market convergence across the Eurozone.

NICOLA MAI: Welcome to today's podcast. I am Nicola Mai, and I am joined here by Sara Adjir and Konstantin Veit. We're going to talk all things Europe today, macro, markets and last but not least, of course, investment opportunities in the region. So Konstantin, Sara, excited to be here with you today. Let me start with a curiosity. Konstantin people on the floor know you for your signature name you give to yourself, KV. Where does that come from?

KONSTANTIN VEIT: I think it was my math teacher in elementary school, actually, who started it and then I just kept it for whatever reason. But yeah, it spread, so quite like, it's short. It's good, particularly good when you go to Starbucks and they'll ask you for your, to leave your name, so.

NICOLA MAI: Much easier. What about you, Sara? Have you ever thought of having a name for yourself? 

SARA ADJIR: No, I think Sara is short enough, so nobody ever tried to shorten it further.

NICOLA MAI: Alright, very good! Let's dive right in. Let's start with macro. So Eurozone growth has been more resilient than expected. 1%, hardly exciting. But for Europe it's actually okay, given the trade frictions and the expectations that were quite low, you know, for the macro picture. Now I would expect this to weaken going forward, given all we've seen on the trade side. But then again, next year there's a fiscal tailwind in Germany.

In theory, trade uncertainty is going to go down. So growth could actually re-accelerate a little bit. On inflation, I would say we're almost at target, basically at target, a little bit above, but not much. So let me turn to you KV, what do you think is the outlook for the ECB given this macro, but…

KONSTANTIN VEIT: Can I ask you only to clarify on the weakening you expect going forward? You don't see a recession right, then the baseline. It's more like something below trend or…

NICOLA MAI: No recession. You're right, I mean, monetary policy supportive. Domestic demand is healthy. I think the trade impact will be felt in the sense that in the first half of the year we had a lot of trade front loading from the US which helped growth, and I think there's going to be some payback. But yes, you're right. I think a stagnation type outlook for the next couple of quarters is the base case, I wouldn't see a recession.

KONSTANTIN VEIT: For ECB, I think is, Lagarde used to say it in a good spot. So growth around trendish, inflation around target and the policy rate around neutral. So, there is not really a reason to do not much. The primary mandate is price stability. So, they don't have a mandate to avoid a recession.

So they will focus on inflation and they had a strategy assessment this year, which has given them some wiggle room to tolerate slightly above or below target inflation over the medium term. Then, under the, obviously condition that inflation expectations remain anchored. So they will not like fine tune if they see that, you know, they will be at 1.9 or 1.8 or 2.2. I don't think they will be overly reactive there. Philip Lane, the Chief economist kind of hinted towards some asymmetry in their reaction function when it comes to the balance of risks around inflation. So he said that, you know, should the balance of risk shifts toward the downside, it might have to do another cut. If the balance of risks is to the upside, on the other hand, they will keep policy rates where it is. In my baseline, I think they're done. They will stay at twofold. The foreseeable futures and other central banks would probably be more, more interesting to watch than the ECB.

NICOLA MAI: Oh, that's interesting! I'm a bit worried sometimes about complacency. You know, I look at labor cost growth slowing very quickly, the FX is stronger, which will weaken inflation. And obviously there's the whole Chinese rerouting possibility and we saw that the EDB missed on its inflation target for a decade. I mean, inflation was 1% on average in the five years before the pandemic.

So don't you think they could be a little bit more complacent or at the very least. Don't just think risks, even if your baseline is unchanged rates, are towards cuts. Would you agree with that?

KONSTANTIN VEIT: I think what is very interesting is that people now casually assume that the euro areas of jurisdiction like any other, like jurisdiction, so they assume 2% is the neutral policy rate for the euro area, and I think the verdict is out there. So I don't have a strong view or like massive disagreement. But we have to remember that not too long ago we have been in negative policy rates.

We talked about Japanification for the euro area, we would never get out there and it was not for good reasons that the ECB could hike rates, right? It was basically a pandemic and the war, so not the good reasons, like an overheating economy that you need to cool down, for example. So then we went from neg 50 suddenly to plus four.

Now we at two and everybody thinks that's kind of the neutral resting point now. But then all these structural forces you alluded to, that kind of kept policy rates low before the pandemic probably haven't miraculously disappeared. So this will be interesting to see, again, no strong view, but the verdict is out, and you could be right that the neutral resting point is probably, it could well be below 2%, call it one and a halfish.

SARA ADJIR: I think we're in a very different state of the world now as well compared to pre pandemic. So there are a lot more chances that because of trade frictions, we're going to see higher inflation going forward. So actually small shocks that we've had in the past and the Eurozone is very exposed to the rest of the world is very dependent on energy, for example. So that's one thing to take into account.

I think we're going to see more bumps in the future that we have in the past. And on the growth, I would add one thing as well is that even though growth has been sluggish and there's not a lot to be excited about in Europe, it's also been very resilient over the past few years. So it's weak, but it's resilient and it's not collapsing.

And it has been, so it has been the case even though the eurozone has gone through a war and through a pandemic. So that, that would be something on the positive side, I would say.

NICOLA MAI: Yeah, there's no doubt that, you know, things are changing. De-globalization and potentially a shift higher in inflation expectations. We'll see if it lasts. But yeah, I guess risks on both sides, but why don't we switch gears and move on to politics. Maybe we can start where it's been a little bit spicy lately, and you know, Sara, you're from France, so I would call on you. What are your thoughts there? Is France doomed or what's your take here?

SARA ADJIR: I don't think it's doomed, and I don't think we are talking about a risk of default definitely for France and we can see that in the market reaction. So the market reaction to the collapse of  Lecomu’s government and to the downgrades from Fitch and S&P has been quite orderly, the market reaction. And I think rightly so, we're not really thinking about risk of default.

The cost of rolling over its debt for France is still very stable. And I think the major challenge that France is facing at the moment is because it has a very fragmented parliament and no strong majority in the government, it makes it very hard for the current government to deliver any kind of significant tightening of fiscal policy.

But at the same time, when we think about it, if the parliament is very fragmented, that also reduces the chances of any extreme policies being passed from the either the far left or the far right. So that also remove some of the part of the right tail of seeing like a very big fiscal expansion that could surprise the markets. So I wouldn't say that there are doomed, but they're definitely facing challenges to tighten their fiscal policy.

And that's the reason why we are a bit more cautious on France. And we think that investors should require more compensation for the risk that they are taking given the deteriorating fiscal picture in France.

KONSTANTIN VEIT: Yeah, I think the, it's quite interesting. I think France hasn't been running a surplus since 1974, so it doesn't seem to be like a long tradition of tightening the belt. But, I think also while the focus is on France right now, this is a global phenomenon that you are seeing, and part of it I think is because central banks have left the field and fundamentals come into sharper relief again.

So there were, we had a long period of time where nobody cared about fundamentals because central banks were just dominating everything and that has obviously changed. You see quantitative tightening in most jurisdictions, record issuance, so there's more scrutiny again on fundamentals and you have, what you've seen in France is not dissimilar to what you've seen in other jurisdictions, basically a warranted repricing on the back of worsening fundamentals, right?

And you've seen this in the US also, keep in mind, Germany had a quite sizable repricing this year in March when after the surprise announcement of the abolishment of the debt break. So a 10-year rates in Germany reprise 50 basis points within a short period of time. And you've seen it in the UK obviously and you've seen this in Japan. So it's kind of a global phenomenon. And so far what you've seen in France, I think looks fairly reasonable in terms of adjustments, of year adjustments during the slightly worse trajectory, now they’re on.

NICOLA MAI: I tend to agree. I mean the bond vigilantes are very much awake. You know, the fiscal metrics that people did not care about until a while back, people are looking at very closely. You know, what I would say is that when it comes to that the GDP trajectory, France is one of the worrying ones. And in a way they have shown to struggle to adjust on the fiscal side. So we will see. But let me shift onto Germany a little bit that you, you brought into the picture.

You're from Germany, KV, so that the GDP is around 60% could move to 80, maybe 90 over the next decade. That's a pretty meaningful shift. So what do you think, will Germany be successful in lifting growth potential? Will they actually spend the money that they're planning to spend, and what do you see as the key implications?

KONSTANTIN VEIT: I'm not like super bulled up on this, I have to admit. So yes, a lot of money will be spent and definitely not enough money has been spent historically. So there's a lot of like under investment and ketchup is certainly needed. So it's good that Germany's opening the door to more fiscal. But if you look at what's going on in Berlin right now, you don't get the impression that the focus is on enhancing the productive capacity of the economy.

And this worries me a little bit, so Germany is still obsessed with competitiveness, so that's the big theme in Germany. Whenever there is a crisis people shout, we need to improve competitiveness, but I think they confuse a bit the concept between competitiveness and productivity. And the German issue is not competitiveness.

I mean, we still run, or Germany still runs a sizable current account surplus, and the US for example, screens very bad on a lot of these metrics, but the US is growing, has much higher growth potential, productivity is much higher. And I would, what I would love to see is more measures that enhance the productive capacity in the economy, a lot is German intrinsic type of story, so they certainly have to do some homework, but a lot obviously links back to enhancing the institutional configuration of the euro area.

And obviously Draghi has published a lot on this, as have others. And the take up so far has been modest and more certainly should be done and needs to be done. So, until I see more progress in these areas and not particularly convinced that growth potential, what do you think where it is now, half percent in Germany?

NICOLA MAI: I would say below 1%, yeah, maybe closer to 1 than 0.5, but close to one.

KONSTANTIN VEIT: Okay. I just don't see right now that there's a lot of efforts to get this up, and that's my main worry when it comes to Germany. Also, I mean, the targets are ambitious in terms of spending the money and as we've seen in other jurisdictions like Italy, spending the NGU money and stuff, it's not trivial. It's easy to allocate, but then actually go through the motions for the bureaucracy. So that takes a long time. So there will be a sugar rush on the back of the money spent. But I'm not sure how long this will last.

SARA ADJIR: I think that's one of the major risk is that you get Germany either not spending all of the money or spending it, but not in the right place. And then a few years further down the line, you end up with worse fiscal dynamics, but not structurally higher growth potential.

And that's one of the reasons as well, why we're seeing a blurring of the lines between periphery and core countries where on one side you have so Belgium, France, Germany, that are more negative trajectories when it comes to fiscal policies over the next few years. And next to that you have Italy or Spain that are faring, but much better on their fiscal tightening and Italy might get out of excessive deficit procedure by the end of the year as well.

KONSTANTIN VEIT: You need to talk about Italy. Nikola, you are Italian? So now it's, now it's your turn.

NICOLA MAI: We’re very well represented here, exactly. European group, and so…

KONSTANTIN VEIT: What's your view on…

NICOLA MAI: My view on Italy is fairly positive. Now obviously things can shift quickly, but I guess the difference between Italy and France right now is that Italy's deficit is much more under control. So even though you start from a much higher debt level almost 140% of GDP, the debt to GDP ratio looks fairly stable, and it's quite an unusual situation to have a pretty stable political dynamic in Italy, which is not the usual through history.

And you have an administration that is pretty prudent on the fiscal side. So I think, it's all good for now. I think Spain, similar considerations, Spain also has had a very strong growth dynamic, partly on the back of immigration. And both countries have benefited a lot from EU funds which have been very generous.

France and Germany have not benefited from that. So the recovery fund has been, again, another sugar rush that will not last forever. But my view on Italy and Spain is generally benign for the foreseeable future. But why don't we move on to the longer-term outlook.

So you asked me about, my view about growth and I think growth potential right now in the Eurozone is close to 1%. In my view, over the next five years, it is actually going to slide further, maybe closer to 0.5% or something like that. Demographics are only going to get worse. You know, we know pretty much how the population is going to move based on fertility rates and so on.

And I think productivity wise, we have massive challenges, you know, Europe is a laggard in technology. It's paying much higher energy prices versus the pre-Ukraine war. It's suffering from very intense competition from China, and it, now we live in a trade environment which is not very friendly to export dependent economies like Europe. So all pretty challenging growth potential is weak.

And as you know very well, we are seeing far right populist parties doing generally very well across Europe, which sounds like a pretty interesting cocktail. So given that, how concerned are you guys, let's start with you KV, about this cocktail, how's the Eurozone going to go through this growth, weakness and strong populist pressure going forward?

KONSTANTIN VEIT: I'm not overly concerned about in terms, when it comes to politics. To be fair, I think it's important that there is a very different geopolitical environment compared to where we've been a couple of years ago, that needs, that basically means Europe needs to rethink its business model, right?

So, we know that Europe was reliant on simply speaking China, when it comes to exports on the US for defense and Russia for energy, it's obviously not something that will work to the same extent or at all going forward. So Europe need to reinvent itself to some extent, and this requires a lot of political will and efforts and money. And I think making progress on the institutional configuration is of paramount importance. So now is really the time to look at the Draghi report and other reports and for example, the capital markets union is a necessary but not sufficient condition.

And a lot has been talked about, for example, you know, after the April Rose Garden episode that you know, oh, a lot of money will flock to Europe now looking for another home. But I think Lagarde said it well, at some stage, the euro will not gain importance by default. It'll have to earn it, and I think it's very well said.

That means Europe has to prepare the ground, earn the trust and come up with proper allocation of capital, friendly, business friendly, productivity enhancing environment. And I guess a capital markets union with deep liquid markets is very important. So I want to see more progress, as I mentioned earlier in these areas. I think we are seeing incremental efforts here and there. But in terms of overall enhancing the productive capacity of the euro area, I think there is much more to be done.

NICOLA MAI: I agree with that. But wouldn't you agree also that, and I asked you a provocative question you know, like there's weak growth in populism. I mean, in my mind, you're right, we need a lot more to have sustainable growth, but then at the same time, if we take stock of what's been done so far, the ECB proving a fairly reliable lender of last resort, you know, fiscal cooperation ultimately coming to the fore when needed, the recovery fund being an example of it. I think we're seeing commitment to unity relative to a decade ago that should…

KONSTANTIN VEIT: I agree, but I would, you typically see that this happens when it's really 12 o'clock, right? The last second, then you see progress. And it would be great to move into an environment where you don't, where you do this proactively, you are ahead of the curve, you know, instead of just reacting to something blowing up somewhere. So that would be helpful.

So now is the time to kind of sit together, look what can be done and then work through it instead of waiting for the next crisis and then, you know, make big progress. I agree with you, the ECB, I mean, we have been discussing till 2014 whether the ECB will ever buy sovereign bonds, right?

That has been settled and we had the NGEU that was in the COVID episode, there was a big stress test. Yes, I agree. So overall, I agree the configuration is stronger and you know, the lines, as you mentioned earlier, between periphery, semi core, core kind of getting blurred and countries transition within it.

SARA ADJIR: I think on the concerns on the rise of populist party as well, I would highlight the fact that the most market unfriendly part of previous populist policies are now gone. So exiting the Eurozone, for example, is not something that's part of the populist party agenda anymore, and that would be one of the things that would be the most explosive for country spreads.

So now that this is price almost priced out, I think that's a positive. Maybe on the margin, you could wonder whether less immigration from what is being pulled by these parties, if that will have an effect on fiscal and countries that have aging population and that are struggling to bear the cost of pensions. But yeah, purely on the less aggressive policies from the populist party, I think that's a positive.

NICOLA MAI: I would agree. And also, I guess in a more adversarial world, the last thing you wanna do is divide. There's an incentive I guess to be more united, but let's now get onto where the rubber meets the road. We're an investment firm. So all of this, what does it mean for investments and what does it mean for fixed income in Europe? What are the opportunities, what are the risks? Whoever wants to start?

KONSTANTIN VEIT: I mean, the, it's interesting because Europe has kind of woken up similar as Japan, by the way. So we had eight years of negative policy rates minus 50 basis points, and that was a very depressing environment. Obviously not easy for a bond shop, but we have pretty good yields now. It looks very interesting. So I would say Europe is investible.

Europe is an interesting place. Europe is now looks interesting also in the global context on a relative value basis, for example. So long story short, euro is back. Europe is investible, and for example, duration of fixed income looks pretty good. And also the other, I think high level point is that, this is an environment where you don't have to take much risk to earn a decent yield on your investment, you know, there was a time not too long ago where you had to be very aggressive in terms of risk taking to earn a decent return on your investment.

You had to be very long in duration, in interest rate risk, you had to be far out the credit spectrum, you know, to get some basis points on top. So that's not an environment we are in now. So that, which is good, Sara, maybe you want to add?

SARA ADJIR: I agree. And I think even though ECB is probably on hold and on that spot, there is not a lot of excitement to expect. I think within the Eurozone there are a lot of good opportunities coming from the converging macroeconomics of core countries versus semi core and periphery as we were mentioning earlier.  Even though we remain cautious on France there are good opportunities to invest and yields are attractive. So, Spain, Italy, or…

NICOLA MAI: And on FX, the euro has obviously gained a decent amount of ground versus the dollar. What's your view, Sara? Is this euro bull run that is going to  last for a long time or what's your view?

SARA ADJIR: I think it's difficult to see a world where the dollar devaluates without euro reevaluating against, I'm not sure if there is a lot more to read into it apart from that, like just a mechanical offset from the dollar weakness.

NICOLA MAI: Yeah. And I guess as you said, KV, I tend to agree with that. I guess the euro strength is not really about euro strength, it's more about dollar weakness and whether that genuine euro strength will come out will depend on whether Euro gets it act together in a way.

Okay. Well we've had a pretty comprehensive discussion today. We've covered a lot of ground from macro to politics to markets to investment opportunities that I think are plentiful these days in fixed income, including in Europe. So thank you so much, Sara! Thank you Konstantin! Until the next one.

KONSTANTIN VEIT: Thank you Nicola!

You’ve been listening to Fixing Your Interest, where we decoded Europe’s journey from cyclical recovery to structural reform. With the ECB’s evolving playbook, industrial policy, and political shifts shaping the investment landscape, understanding these forces is key to navigating the Eurozone. Enjoyed the discussion? Share this episode with your network, follow Fixing Your Interest on your preferred podcast app, and explore exclusive research and commentary at PIMCO.com to stay informed on the latest market developments.