Investors withdrew close to €14bn from European corporate debt funds in the first three months of the year, the worst quarter since the start of the pandemic, as the war in Ukraine fired up already rapid inflation and stirred market volatility.
So-called investment grade debt — at the safer end of the spectrum — lost 5.4 per cent for investors at the start of 2022; again, the worst since the darkest days of the Covid markets shock, while high-yield bonds lost 4.3 per cent.
US corporate debt markets — which are less exposed than those in Europe to the war in Ukraine — have held up somewhat better in terms of their performance compared to US Treasuries, with the so-called spread in yields well below any signal of distress.
The gap shows investors are braced for sanctions on Russia, particularly in energy, to hurt corporate Europe, with the added chance that a more restrictive stance from the region’s central bank could exacerbate recession risks.
“If there’s a place we don’t want to be right now, it’s [eurozone] credit,” said Florian Ielpo, multi-asset portfolio manager at Lombard Odier Investment Managers. Higher costs for companies and the possibility of rising interest rates are a troubling combination for the asset class, he said.
Russian president Vladimir Putin’s invasion of Ukraine has raised prices for food and fuel, sending annual consumer price inflation in the eurozone as high as 7.5 per cent. Economic growth forecasts have dropped, creating a dilemma for the European Central Bank, which is under pressure to pull back its ultra-loose monetary policy to dampen prices.
After a bumper 2021, “Europe has underperformed”, said Mike Scott, lead portfolio manager at Man GLG. “Cyclicals, industry, as well as single B credit and below . . . these are the areas of the market that have seen the greatest amount of pressure.”
In addition, market volatility has more or less stopped the flow of new risky corporate bonds in Europe. Markets had effectively closed to speculative issuers for almost five weeks because of the geopolitical turmoil.
Yet despite the outflows from funds and the slowdown in issuance — debt issuance by companies excluding banks stood at around half its 2021 level between January and mid-March this year — analysts say European companies are relatively well-positioned to cope with rising borrowing costs.
Companies spent much of the pandemic loading up on cheap debt and locking in longer-term repayment schedules, meaning rising interest rates are unlikely to be as damaging today as they have been in the past. “Near term speculative [refinancing] risk is limited,” said S&P Global, which notes that around 90 per cent of debt maturing through 2023 is investment-grade.
European high-yield default rates ticked up in March to end a run of 10 consecutive monthly declines. JPMorgan, for one, appears unfazed. Although investors are “concerned about macro risks to credit arising from monetary policy and geopolitics, they are also struggling to identify potential default candidates,” the bank said in a note.
Some higher-risk companies are slowly coming back to the market. German drug and agrochemical conglomerate Bayer late last month raised €1.3bn, with Italian bank Intesa Sanpaolo issuing €1bn of debt and Finnish nuclear power company Teollisuuden Voima raising €600mn.
The war in Europe and its effects on inflation and central bank policy have been largely priced in by investors, said Man GLG’s Scott. “I believe there is a window of opportunity for deals to start coming to the market,” he added. “But is the market ready? Unlikely.”
(This article has been amended to clarify the performance of US markets.)