The European credit is poised for a renaissance

After the worst first half in memory for European credit markets, the ship has steadied. The euro-aggregate index rose 4% in July, its best month ever. That reversed a similar-sized loss in June, which punctuated a 13% drop in the first six months for supposedly safe investment-grade bonds. In the midst of high summer, as is to be expected, there are only a handful of new corporate bonds being sold, but all the signs point to activity roaring back as vacation season ends. There is certainly plenty of slack after a record 33 days of zero issuance this year.
With the jump in interest rates — combined with a sustained widening of credit spreads of corporate bonds over government benchmarks — it’s been a rocky market for anything other than highly liquid well-known companies. Even those have to be attractively priced, as the premium that issuers have to offer over existing debt increased substantially from the halcyon days of 2020 and 2021. The days of negative yields that even some highly rated companies enjoyed are long gone. It’s a whole different landscape for fixed income with the European Central Bank ending sub-zero rates and winding down quantitative easing.
But several deals show that household names with an attractive credit spread are receiving impressive investor interest — despite the summer lull.
Volvo AB sold 500 million euros ($510 million) of five-year notes with demand more than six times the amount on offer. Cie. de Saint-Gobain SA brought a three-part 1.5 billion-euro deal, including a sustainability-linked 10-year. Scottish energy company SSE PLC sold a 650 million-euro seven-year green deal that saw an order book nine times the issued security. Green-linked bonds accounted for 23% of total issuance this year, running behind last year’s pace of 27% — but conditions are not comparable. The future is still very much chartreuse-tinted.
While the pandemic clobbered primary debt markets when it hit in March 2020, the vast fiscal and monetary stimulus that followed led to a surge in debt raising, with commensurate investor demand to match. So much so, that as business had drunk long and deep at the well, there is currently much less pressure for funding. This vacuum won’t last forever, and while underlying yields and credit spreads are certainly more elevated than at the start of the year, the new normal has to start somewhere. For fairer comparisons, it’s wiser to assess this year’s total with pre-pandemic tallies.
Corporate treasurers have to factor in two elements when deciding whether to borrow in the bond market. First, underlying market interest rates: The benchmark German 10-year bund yield started this year at minus 11 basis points, but soared to 1.77%. With yields now around 1%, it is considerably less scary to test where new funding levels might reasonably be.
The second element is the yield premium that riskier companies have to offer above governments, and that has subsided also. The iTraxx five-year euro investment grade credit default swap index, which was less than 50 basis points in early January, peaked at 127 basis points in mid-July, but has fallen back close to 90 basis points. That means the cost of raising funds for mainstream companies has, on average, reduced by over 100 basis points in the past month.
There are storm clouds on the horizon, with the energy crisis likely becoming more acute heading into winter, and potentially market-moving Italian parliamentary elections due on September 25.

—Bloomberg