Mitigating European political risk – Counterpoint October 2026

Why politics matters more today

The global economy remains resilient, and earnings growth continues to be supported by healthy demand, particularly in the US. Yet the main change in our thinking this month is not about growth. It is about political risk.

France’s 2027 presidential election is likely to be an important test for markets. Concerns around fiscal sustainability, political fragmentation and the future direction of economic policy in the Eurozone are already influencing market sentiment. 

Italy and Spain will also hold elections in 2027 and November 2026, respectively, potentially adding to the political uncertainty surrounding European government bonds.

Markets have already reflected some of these concerns. French equities and government bonds have underperformed, and investors are paying closer attention to risks around government debt levels in Europe. However, we don’t think the risks are fully reflected in current government bond prices.

We’re changing our bond allocation

We are reducing our allocation to European government bonds from overweight to neutral. This decision is more about political and fiscal risks rather than a view on the level of yields. 

While there are pockets of fiscal resilience in Europe, particularly in Germany, the Eurozone as a whole still faces difficult choices. France and other economies, including Italy and Spain, have high debt levels. This limits the room for governments to respond to economic shocks through additional spending. If uncertainty around these governments’ capacity to spend increases, investors may demand higher yields to hold their bonds, leading to falling bond prices.

Shifting towards US Treasuries

Against this backdrop, we are increasing our exposure to US Treasuries to a moderate overweight. At the same time, we are hedging our US dollar exposure in Treasuries back into euros or sterling, depending on the portfolio’s currency. 

Our aim is not to target a particular income differential between the US and the Eurozone. Rather, we do this to shift part of our bond exposure towards a market where we see fewer immediate political and fiscal risks.

The US is not without political uncertainty. The upcoming midterm elections could change the balance of power in Congress and make large government spending initiatives harder to implement. Absent new expenditure initiatives, no further budget deterioration or even a moderate consolidation looks likely, though it would not necessarily rapidly reduce the US budget deficit. This could provide some support US Treasury markets.

There is also an interest rate angle. Current bond prices also reflect expectations of several further interest rate rises. Unless inflation worsens, we think the Federal Reserve (Fed) is unlikely to raise rates more than investors already expect. If geopolitical tensions ease and oil prices fall, inflation pressures could also lessen, which would provide further support To US Treasury prices.

Growth still supports equities

Although political and fiscal developments have influenced our government bond positioning, our broader investment outlook and market strategy remain relatively constructive.

The global economy continues to grow despite higher interest rates and political uncertainty, with the US providing much of the momentum. Consumer and corporate spending remains healthy, while the AI investment cycle is increasingly visible in capital expenditure, technology demand and corporate profits.

Inflation is proving more persistent

The inflation problem has not disappeared, but it is no longer as broad-based problem as it was in 2022. That distinction matters because it should limit the scale and speed of any monetary policy response.

Underlying inflation, which excludes volatile components such as energy and food, is much closer to central bank targets than it was during the inflation surge of 2022. At the same time, higher oil prices and geopolitical tensions are pushing headline inflation higher, creating a difficult trade-off for policymakers. 

We expect the Fed, European Central Bank (ECB) and Bank of England (BoE) to all raise interest rates in the near term. The Fed and the ECB have already started, the BoE might follow after the Autumn Budget.

However, we do not expect a repeat of the rapid tightening cycle that followed the pandemic. The drivers of inflation are different today. In 2022, economies were reopening after strict lockdowns, demand was exceptionally strong and supply severely disrupted. Today’s inflation pressures are narrower, primarily linked to energy prices and geopolitics.