Union Connect: Is Trump supporting European bonds?

Trump's policies are causing fundamental changes in the currency market
Europe and the euro are in a better starting position
Divergence between key interest rates and inflation caused by politics
Euro bond investors can breathe a sigh of relief
Focus on corporate bonds with high credit ratings and pay attention to duration

The dollar, as a barometer of confidence in the US, is under pressure. Since the beginning of the year, the US dollar index, which compares the value of the US dollar against a basket of six other currencies, has lost almost ten per cent. Against the euro, the decline is almost 12 per cent. In fact, the US currency should actually depreciate further in real terms, as some valuation models show in historical comparison: according to these models, the US currency is still overvalued (see chart).

Real devaluation needed to balance exchange rate and current account

Euro is fairly valued, US dollar significantly overvalued*

Source: Union Investment, as at 23 October 2025. * Assessment based on the Fundamental Equilibrium Exchange Rate Model (FEER).

The chaotic policies of US President Donald Trump are cited as a key reason for the weakness of the dollar. In the spring, the tariff conflict on 'Liberation Day' caused the US dollar to slide, leading to unusual market turbulence. This is because the currency of a country that imposes import tariffs on goods usually appreciates, rather than depreciating as in this case.

Trump's policies are causing profound changes in the currency market

Instead of buying US government bonds, which were previously considered a 'safe haven', market players fled from these securities. This was accompanied by a decline in prices. Usually, in phases when the capital market reduces risk (‘risk off’), capital flows from US investors flow into the United States. In the spring, this was less pronounced, while foreign investors also withdrew more funds from the US. Only when Trump backtracked on his tariff threats did the situation calm down.

Now investors are wondering whether something like this could happen again. Has the status of the world's largest financial and government bond market been irreparably damaged? And what does this mean for their own bond portfolios?

Expectations that international investors would flee the dollar en massein large numbers also were exaggerated. To date, the reallocation of flows into other currency areas has remained moderate.

However, it would be a mistake to believe that everything will continue as before. Although a systemic crisis is extremely unlikely, Trump's authoritarian economic, trade and security policies are creating less favourable conditions for the world's largest economy and most important capital market. The seizure of foreign assets deposited in the US has also raised concerns abroad. All of this stands in the way of a stronger US dollar in the near future – at least from a European perspective. This is because the negative factors on the US side are too diverse, while conditions for a more stable euro exchange rate are in place in the eurozone.

Europe and the euro are in a better position

A comparison between the US and the eurozone shows that the US has a persistently high current account deficit – unlike the eurozone. And despite the introduction of import tariffs, there is no sign of a substantial improvement in the US trade balance – the imbalance remains. Furthermore, the cost of servicing US debt in terms of government bonds is expected to exceed two per cent of gross domestic product (GDP) over the next ten years, adjusted for inflation. The reason: government debt continues to rise and a return to the extremely low key interest rates of the past seems unrealistic. The increasing supply of government bonds is meeting with little demand. In the longer term, yields on US government bonds could rise significantly.

In addition, according to our experts, Europe is facing a 'major transformation'. The old continent is striving to stand on its own two feet in terms of security and trade policy, which requires high investment in defence and infrastructure. This willingness not only increases government debt, which is lower than in the US and thus offers room for manoeuvre. The fiscal programmes also strengthen Europe's growth potential in the long term, provided the funds are used wisely. This could increase the attractiveness of the euro as an international reserve currency.

Divergence between key interest rates and inflation trends

Another important point is that the US Federal Reserve (Fed) is under enormous political pressure. With attacks such as those on Governor Lisa Cook, Trump is attempting to sway the majority of the committee responsible for monetary policy in his favour. The aim is to achieve a significantly looser monetary policy. We expect the Fed's independence to be gradually eroded, leading to lower key interest rates than would actually be appropriate from a fundamental perspective. At the same time, we expect the European Central Bank (ECB) to continue to take its mandate of price stability seriously. We therefore consider a temporary, prolonged divergence in central bank policy, which is not fundamentally but politically motivated, to be possible. At the same time, inflation is drifting apart between the US and the eurozone – in opposite directions. Despite an inflation rate of around three per cent, the US Federal Reserve is therefore likely to continue lowering its key interest rate, which will reduce short-term real interest rates and make investments in US dollars less attractive. If the ECB leaves its key interest rate unchanged at the same time, this will strengthen the attractiveness of the euro for investors. This factor also supports the euro exchange rate.

Euro bond investors can breathe a sigh of relief

What does this mean for a bond portfolio? The good news is that European bonds are benefiting from US President Trump's policies. Until now, US dollar investments have dominated the financial market compared to investments in other currency areas. The erratic nature of US politics will force investors to diversify their assets more. This also plays into Europe's hands – and is likely to lead to a slight inflow of funds into the euro and euro-denominated bonds, which will support their prices.

However, the current development also harbours risks. The erosion of the US Federal Reserve's independence could cause inflation to rise more sharply than expected, making it more difficult to contain. The rise in US debt as a result of Trump's budget policy also poses risks, particularly for longer-term US government bonds. The resulting higher price volatility could spill over into the European bond market and cause unrest there.

Focus on corporate bonds with high credit ratings and pay attention to duration

However, in our view, European corporate bonds remain well protected in this environment. While government debt will rise more sharply and we expect higher term premiums for longer-dated government bonds, the fundamental outlook for companies with strong balance sheets is very good. What's more, although the market for euro-denominated corporate bonds with good credit ratings has reached a considerable volume of €3.2 trillion, it is still significantly smaller than the dollar market, which has a volume of €7.8 trillion. This means that even marginal changes in inflows into euro-denominated securities have a significant positive effect on prices.

Clear lead for US corporate bonds

European corporate bonds have only been gaining ground for two years

Source: Bloomberg, Union Investment. As at 10 October 2025.

This assessment is underpinned by the level of issuance activity. This year, the investment-grade segment is likely to reach a record placement volume of over €600 billion. At the same time, demand has risen sharply, particularly from private investors. This is driven by the search for additional returns with comparatively low risk. More and more investors are tending to purchase corporate bonds as a substitute for low-risk government bonds. Overall, therefore, European bond investors should not react rashly. It may be advisable not to enter into too long durations and to hedge US dollar holdings against exchange rate fluctuations. This should ensure that a bond portfolio is well positioned.

Source: Union Investment. All information, explanations and illustrations are as at 29 October 2025, unless otherwise stated