How a selective approach to European bonds could deliver long-term value for ETF investors

A stable economic backdrop, easing monetary policy and strong fundamentals are creating a favourable environment for European government and corporate bond exchange-traded funds (ETFs).

Uncertainty over US tariffs has faded, after the European Commission agreed a trade deal with the US in July, though there remains scope for surprises on a global scale. Elsewhere, political risk and fiscal concerns cannot be discounted – but with the ‘tariff tantrum’ behind us, investor attention is now shifting to the broader macroeconomic environment.

The continent’s economic growth is admittedly modest, at best – Eurozone GDP rose 0.1% in the second quarter (Q2) and was up 0.2% across the broader European Union, compared to growth of 0.6% and 0.5% respectively in Q1. More positively, the latest S&P/HCOB Purchasing Managers’ Index showed that Eurozone business activity continued to expand in September, with the index reaching a 16-month high.¹

Meanwhile Eurozone inflation has remained at, or close to, the European Central Bank’s (ECB) 2% target, edging up to 2.2% in September from 2.0% in August.

The ECB has kept interest rates unchanged since June, and markets see little to no chance of another rate cut this year, with the potential for a cut in mid-2026. This pause in the monetary easing cycle is beneficial for traditional ETF bond strategies, supporting yields, which tend to fall when interest rates are cut. 

Rising issuance and inflows

Monetary easing is also underpinning a buoyant credit backdrop, making it cheaper for corporates to borrow; this is demonstrated by relatively high levels of corporate bond issuance and tight spreads in credit markets. At the same time, the artificial intelligence boom is fuelling confidence – so-called animal spirits - and this is flowing into the bond market as well as equities.

European government bond issuance is also expected to ramp up after Germany loosened its fiscal debt rules to allow it to borrow more to fund defence spending. Meanwhile the European Commission is continuing to use debt issuance as a way of funding programmes like NextGenerationEU. This creates potential new opportunities for ETF investors to capture yield in longer-dated bonds.

In the Eurozone government bond market, longer duration has outperformed its shorter duration counterpart this year and continues to remain attractive. Within credit, investment-grade bonds continue to attract strong inflows, with investors seeking yield even though spreads are tight. There is little evidence of underlying credit problems as corporates and financials have reported strong earnings.

Overall European investment funds – both equities and fixed income - attracted some €131bn of inflows in the second quarter of 2025, according to Morningstar².

Supported by strong fundamentals

In its October 2025 Fiscal Monitor, the International Monetary Fund (IMF) warned that global public debt is projected to rise above 100% of GDP by 2029³ with a rise in government borrowing costs making bond markets more fragile. However, the IMF cited France and Italy as among those with “deep and liquid sovereign bond markets”.

This underscores the fact that whether it is government or corporate bonds, not all issuers are created equal. There is increasing divergence – and opportunities for diversification - across sectors and countries within Europe, meaning active selection within ETFs is crucial. An active approach can help seek out opportunities across the spectrum regardless of the market environment. Aggregate portfolios give active managers the scope to manage both interest rate and credit risk to help to achieve performance.

While credit fundamentals remain solid, and default risk is low, providing a buffer against potential economic headwinds, uncertainties around growth and inflation mean a prudent and selective approach remains essential. Identifying strong fundamentals, prudent financial management, and sectoral resilience is key to capturing long-term value for ETF fixed income investors.