Even before the recent trade turbulence, global asset allocators were re-assessing their European exposures in a more positive light. Germany moved away from fiscal restraint, comprehensively re-rating European growth. Domestic and foreign investors closing their equity holdings gap in developed European, Middle Eastern and Asian markets relative to the US was well within our expectations. Germany was fully on course, heading towards stronger fiscal impulse following the federal election in February.
However, the seismic shift in Germany’s assessment of the European security architecture has led to a rethinking of national priorities. The spending push is well above any prior expectations and, as the funds are designed to stay in Europe, every economy linked to Germany’s industrial chain will benefit. US tariffs, irrespective of their end-state, will only strengthen the trends already in place, notwithstanding short-term volatility.
For now, we see stable to slightly negative currency flows in the euro. European equities will continue to benefit from longer-term domestic and cross-border interest. European sovereign fixed income for now is mostly attracting flows into Germany, and we reserve judgement on the notion that the euro area will benefit from mass rotation due to stronger safe-haven status.
Foreign exchange
At the end of 2024, political risk, growth weakness and expectations for sustained European Central Bank easing pushed cross-border euro holdings to the weakest level in nearly two decades.
BNY custodial iFlow data, which provides insights into cross-asset investment flows, show overseas investors were excessively hedging their euro area assets. Through Q1, the unwinding of such hedges augmented euro-positive factors, such as a less dovish ECB, European defence spending plans and more recent tariff-related changes to global asset allocation.
Figure 1. Cross-border holdings in euro have recovered to average levels
Scored weekly holdings
Source: BNY
The same data show the euro move now is excessive and represents a tightening in financial conditions, which requires an offset by the ECB. Crucially, the same cross-border holdings have recovered to the average level over the past year (Figure 1). This will allow fundamental drivers like carry and growth to have a stronger role in determining price action for the euro.
Equities
Towards the end of Q1, equity holdings data from BNY iFlow also show a peaking in allocations to Europe. Understandably, there was always a risk of a material adjustment lower. The tariff shock aggravated the moves, but holdings data indicate resilience in the European defence theme.
In the March ECB rates decision, President Christine Lagarde stressed that German stimulus would lift growth, and global holdings remain 25% above their one-year average. This indicates that there has been very limited outright selling to augment the decline in levels.
Figure 2. Automotive sector remains worst performer
Scored daily holdings, January-April 2025
Source: BNY
However, other sectors exposed to global growth and external demand are clearly struggling. The automotive sector remains the worst performer as fears over structural decline were already in place well before 2 April (Figure 2). In contrast, the luxury goods sector initially aligned well with defence, but the two sectors have diverged sharply as asset allocators see the latter as far more exposed to the deterioration in the global growth outlook.
European fixed income
Recent developments in US Treasury markets have ignited a discussion on alternative reserve assets, especially for asset managers with a mandate to invest only in highly rated government securities. However, this is easier said than done. Our data show that there has been very limited inflow to the highest-rated assets in mid-April. Triple-A names such as Australia and Sweden only found bids after consistent sales in Q1.
On the other hand, Bund flow has been solid year-to-date. Preference for the market has been clear since the end of February for domestic reasons, and for now we would not characterise the market as over-extended either (Figure 3).
Figure 3. Preference for Bunds has been clear since end of February
Scored daily cross-border flow in Bunds, January-April 2025
Source: BNY
On a cross-border basis, the original flows were most likely linked to the European reinvestment and rearmament narrative due to new geopolitical and security realities. However, equally strong flow over in the first half of April has reinforced the safety qualities of the Bund market.
Furthermore, with ECB easing now the base case for future meetings and the euro’s surge further dampening inflation expectations, there is clear upside risk to euro area real rates, which in itself will not conflict with the change in the euro area’s growth narrative as competitiveness improves. Lower German yields should also help anchor the rest of the euro area, especially as joint issuance is now becoming a more sustainable narrative. Flows into other markets such as France and Italy were more neutral, but there is little sign of intra-euro area divergence taking place.
Volatility will persist, but we believe the flow consistency into Bunds and European sovereigns is here to stay, independent of wider drivers.
Geoffrey Yu is Senior EMEA Markets Strategist at BNY.
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