The recent volatility of the European spread complex has forced the ECB to open a discussion on a possible anti-fragmentation tool to be possibly presented at the July meeting. The question of whether credit will also be supported by the European Central Bank remains wide open as no comments have been made in one sense or the other.
Since the ECB emergency meeting credit spreads have largely underperformed peripheral sovereigns as some market participants are expecting the ECB to possibly sterilise the purchase of BTP or Bonos via the selling of other bonds, including corporate ones. We are of the view that credit should be supported as the corporate bond market is already showing signs of great vulnerability. Not only the private space and the lower end of the high-yield market are under pressure but also IG with the real estate sector, currently in a very distressed scenario (see chart).
EUR IG Spread vs Rating
Hence we do prefer the Investment grade to semi-core and peripheral sovereigns. IG levels are currently incorporating a severe recession scenario, and expect spreads to trade in range into year-end. For High Yield, we are more cautious as we think corporates will feel the pressure of the economic slowdown that has not yet been reflected in companies’ earnings.