Credit markets: decompression in sight

Euro Credit markets are among the best performers year to date compared to other liquid asset classes. Yet spreads after a tightening in March have widened recently to incorporate lower growth prospects associated with a high level of uncertainty. At current level spreads are consistent with our economic scenario which comprises low growth but no recession.

Corporate fundamentals will slightly deteriorate over the coming quarters. European default rates should pick up from 1.5% in early 2022 to 3% at the end of the year. Ratings will also deteriorate, mostly in very cyclical sectors and the lower end of the rating spectrum. Technicals should not be of great help either.

The ECB will stop purchasing bonds in a few weeks and despite outflows have largely stopped since March and we are not seeing money returning to credit yet despite attractive absolute yields. For instance, Euro BBBs are now yielding 2.3% a few basis points away from the Covid peak. Yet the decompression hasn't yet taken place.

This should not last as downward economic revision will hurt HY the most and more worrying the quasi closure of the HY market for more than two months will either result in very wide new issue premiums, or a severe repricing of the liquidity premium, both pressuring secondary levels. Hence, we continue to keep an OW in credit but a very defensive one with a preference for IG over HY.