European corporate debt was hit by its largest ever decline as fears of still-high inflation and the threat of a recession prompted traders to pull out of the market.
According to an Ice Data Services index.
Much of the damage stems from expectations that the European Central Bank will follow the US Federal Reserve in raising interest rates as it grapples with runaway inflation. On Wednesday, ECB chief Christine Lagarde indicated that she would support a rate hike in July.
This perspective has touched ties on all sides. But the so-called spread offered by corporate bonds – the extra yield they offer over government debt – has also started to widen, indicating that investors are worried about an impending economic slowdown that will could weigh on companies’ ability to service their debt.
The selloff was prompted by “stickier-than-expected inflation,” which fueled expectations of central bank tightening, said Vivek Bommi, head of European fixed income at AllianceBernstein. “In September the word used with inflation was ‘transitional’ and I don’t think anyone uses that word anymore.”
The pressure on corporate bonds mirrors strains in other fixed-income asset classes, almost all of which are seeing “pretty large outflows,” Bommi added.
High-yield bonds issued by companies with lower “junk” credit ratings have also been hit, although the sell-off has so far proved less intense than the run into risky assets seen at the start of the pandemic. of coronavirus. European junk bonds have collectively fallen 10% on a total return basis so far in 2022, according to an Ice Index.
Spreads on these European high yield bonds, which indicate investors’ perception of default risk, also increased to 5.15 percentage points from 3.31 percentage points since the start of the year, the highest level wider since July 2020.
Still, some investors wonder if this relative resilience is likely to last given the threat to economic activity posed by soaring energy prices.
“There was a synchronized selloff that was driven by interest and inflation, with the high quality underperforming more than the lower quality market,” said Mike Scott, portfolio manager at Man Group specializing in credit. . “We expect that to reverse as we enter the second half of the year,” as the economic outlook for Europe darkens, he added.
The widening of spreads “indicates that there is higher risk in corporate credit, but also shows that as financial conditions tighten, with the ECB saying it will not buy more corporate bonds. European companies, the lack of demand is leading to a revaluation of bonds,” said Daniel Lamy, director of European credit at JPMorgan.
“Growth prospects have been further challenged over the past month or so due to the war in Ukraine, lockdowns in China and inflation eating away at consumer demand,” Lamy said.
Additional reporting by Tommy Stubbington in London