European credit is poised for a renaissance

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After the worst first half in memory for European credit markets, the ship has leveled off.

The aggregate euro index rose 4% in July, its best month ever. That reversed a similarly sized loss in June, which punctuated a 13% drop in the first six months for supposedly safe investment-grade bonds. In mid-summer, as you might expect, there are only a handful of new corporate bonds sold, but all signs point to a pick-up in activity at the end of the trading season. holidays. There is certainly a lot of slack after a record 33 days without emissions this year.

With interest rates soaring – combined with a sustained widening of corporate bond credit spreads over government benchmarks – the market has been tough for anything other than highly liquid well-known companies. Even these need to be priced attractively, as the premium issuers have to offer over existing debt has risen significantly from the heyday of 2020 and 2021. The days of negative yields that even some well-established companies enjoyed rated is long gone. It’s a whole different landscape for fixed income, with the European Central Bank ending sub-zero rates and quantitative easing.

But several deals over the past week show that household names with an attractive credit spread are attracting 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 offered. Co. of Saint-Gobain SA has concluded a three-part agreement worth 1.5 billion euros, including a 10-year duration linked to sustainable development. Scottish energy company SSE PLC sold a seven-year, €650 million green deal that saw an order book nine times the issued stock. Green-related bonds accounted for 23% of total issuance this year, lagging last year’s 27% pace, but the terms are not comparable. The future is still very Carthusian.

While the pandemic rattled primary debt markets when it hit in March 2020, the massive fiscal and monetary stimulus that followed led to rising debt, with commensurate demand from investors. So much so that, since companies had been drinking long and deep from 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 higher 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 counts.

Corporate treasurers need to consider two things when deciding whether or not to borrow in the bond market. First, underlying market interest rates: the yield on the benchmark 10-year German Bund started this year at minus 11 basis points, but climbed to 1.77%. With yields now around 1%, it is much less scary to test where new funding levels might reasonably be.

The second element is the yield premium riskier companies have to offer relative to governments, which has also declined. The iTraxx euro five-year investment grade credit default swap index, which was below 50 basis points in early January, peaked at 127 basis points in mid-July, but fell back to nearly 90 basis points. This means that the cost of fundraising for consumer companies has, on average, fallen by more than 100 basis points over the past month.

Storm clouds are looming on the horizon, with the energy crisis likely becoming more acute as winter approaches and Italian legislative elections are likely to affect the market on September 25. for consumers, particularly on residential mortgages. Access to wholesale bank funding has also deteriorated, which will be a major concern for the ECB should it deteriorate further.

September is going to be a big test for investors’ appetite, especially whether the QE freeze has been fully priced in. The ECB is sitting on 344 billion euros of high quality corporate debt. It reinvests maturing bonds in the market at a rate of more than 2 billion euros per month, of which around a quarter has been invested in primary transactions. Nevertheless, the overall impact of the purchases is considerably reduced, as the ECB no longer adds around 5 billion euros per month of new purchases. However, investors should rejoice in the absence of the largest buyer crowding out much of the available liquidity float in European investment grade.

As long as market volatility remains subdued, the second half of 2022 should be significantly more active for corporate debt supply. It’s hard to imagine borrowing costs being as cheap again as they were last year, but with the recent easing of markets, yields are bearable for businesses, yet attractive enough for investors to look forward to. put back in the water. A quiet period in September should hopefully see a series of new deals appear, leading to better access to finance across Europe.

More from Bloomberg Opinion:

• ECB crisis plan fails to convince bond traders: Marcus Ashworth

• The Goldilocks era of Private Equity is coming to an end: Nir Kaissar

• The bond market yield curve has gone astray: Robert Burgess

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.

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