Complex US picture helps the case for European bonds

August 28, 2025 - 3 min

Paul Lentz
Bond Analyst
DNCA Investments

De-dollarisation is an ongoing phenomenon, but it'll take longer than people might think. Over the span of the last 500 years, we've seen empires rise and fall and, with them, their reserve currency status. Today we're probably witnessing the start of this multi-decade phenomenon for the US dollar. However, in the short term, the US dollar is poised to remain the international trade and reserve currency.

What are your views on de-dollarisation?

Despite the political noise coming from the US, the recent weakening of the dollar appeared to be more of a cyclical adjustment rather than the beginning of the shift away from the currency. The main reason for that is the absence of any credible alternatives. The Euro area is too fragmented. China lacks market infrastructure and BRICS or any multi-country global currency looks more fiction than reality for now. Therefore, despite the recent market turmoil and the confidence shock coming from the US, decades of rule of law and democracy still protect the dollar's reserve currency status.

Which macroeconomic factors do you see influencing fixed income into 2026?

In Europe, macro is fairly easy to read, slow but steady growth, relatively low inflation and inflation expectations, stable labour markets, and a central bank that is close to being done with its cutting cycle. In the US, things are not as straightforward. There are two key factors to watch. First, if the labour market continues to weaken in the context of a shrinking labour force, and second, if and when tariff-induced inflation begins to pick up, and whether the prices of other goods and services start to rise as well. In the developed world, outside of Japan, the direction of central bank policy is still clear. It's down. The next move is likely still a cut, and it's far too early to start thinking about hikes. Finally, now that trade uncertainty is finally beginning to dissipate, the biggest risk comes from loose fiscal policy and how the market tolerates higher levels of debt going forward.

What are the characteristics of inflation-linked bonds?

With real rates at levels not seen since before the great financial crisis, the slowing global economic context still supports a general easing of real interest rates. Given the inflationary risks in the US and the very low inflation expectations in Europe, we believe that inflation-linked bonds, which are government bonds that adjust their interest and principle based on inflation offer an attractive risk return profile, exposure to lower interest rates, and a protection against rising inflation.

What other opportunities are you seeing?

We are seeing opportunities in the bond space in Europe. The significant steepening of the curve, coupled with a building risk premium, has pushed valuations into attractive territory for the first time in years. Local currency emerging market bonds are also starting to look attractive, but the timing to enter the trade could be challenging during the second half of the year. Volatility and the curve tend to move together. Historically, outside of very specific episodes, the higher volatility tends to create steeper curves, which can look attractive from a carry perspective. However, as you know, higher volatility also means higher risk. Therefore, if you're interested in the dynamic of rates rather than the absolute level, you have to look at valuation from a risk-adjusted perspective to find opportunities in the fixed income market.

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