Bond managers shift towards Europe amid global uncertainty

European bonds are gaining favour among global fund managers as policy uncertainty, fiscal strain and geopolitical shocks make risks in larger debt markets harder to assess.

Portfolio managers are increasing exposure to euro-denominated government and corporate debt, attracted by yields that now offer meaningful income and by monetary conditions that appear more predictable than those in the United States or Japan. The shift does not amount to an abandonment of US Treasuries, but it marks a reassessment of where defensive capital can be deployed with fewer surprises.

Government bond markets have become increasingly sensitive to political decisions, energy prices and changes in currency policy. Long-dated US Treasury yields have climbed to levels not seen for almost two decades, reflecting unease over inflation, heavy federal borrowing and uncertainty surrounding the Federal Reserve’s policy direction.

The 30-year US Treasury yield rose above 5.2 per cent after the Federal Reserve kept rates unchanged and offered limited guidance on its next move. The steepening yield curve has increased the risk of capital losses for funds holding longer-duration securities, even as shorter-dated bonds continue to provide attractive income.

Japan has added another source of volatility. Efforts by Washington and Tokyo to support the yen have raised concerns that Japan, one of the largest foreign holders of US government debt, could reduce Treasury holdings to finance further currency intervention. Rising Japanese government bond yields are also making domestic assets more competitive for the country’s insurers and pension funds.

Europe presents a different mix of risks. Fiscal expansion, defence spending and infrastructure investment are increasing bond supply, particularly in Germany. Yet fund managers see the region’s policy framework as easier to model because inflation has moderated and interest rates are expected to fall relative to those in the United States.

German Bunds remain the benchmark defensive asset in the euro area, while French, Spanish and Italian debt provides higher yields for investors willing to accept additional credit and political risk. Italy’s bonds have continued to attract demand as the spread over German debt remains contained, supported by stable economic management and access to European Union investment programmes.

The 10-year German Bund yield has traded around 3.1 per cent, below comparable US and British borrowing costs. Lower currency-hedging expenses can further improve returns for some international investors, especially when uncertainty surrounding the dollar reduces the appeal of US assets.

Corporate bonds are also drawing interest. Euro investment-grade companies generally carry less leverage than many US counterparts, while the region’s banking system has strengthened capital and liquidity buffers. Higher yields have restored the income component that disappeared during Europe’s era of negative interest rates.

Demand is spreading beyond sovereign and investment-grade debt. Selective European high-yield bonds are attracting managers seeking stronger returns without taking the full duration risk associated with long-term government securities. Fund houses remain cautious, however, because energy disruption, weak growth or renewed trade conflict could quickly widen corporate credit spreads.

European mutual funds and exchange-traded funds recorded estimated net inflows of more than €423 billion during the first five months of 2026. Bond products experienced a sharp rise in demand during May, although equities remained the largest contributor to overall fund sales.

The inflows reflect a broader search for diversification. Bonds have become less reliable as protection against equity losses because inflation shocks can push both asset classes down together. Funds are therefore spreading exposure across countries, maturities and currencies rather than relying on a single government bond market as a universal haven.

Europe’s appeal is not without limits. Governments are preparing to borrow heavily to finance defence, energy security and industrial policy. A sustained increase in issuance could place upward pressure on yields, while political instability in major economies could weaken investor confidence.

The euro area also remains vulnerable to energy shocks. Disruption to oil and gas supplies through the Middle East could revive inflation and delay monetary easing. A sharp rise in fuel prices would place particular pressure on industrial economies such as Germany and Italy.