European High Yield - January 2016
The Outlook for European High Yield Bonds in 2016
How will European High Yield fare in 2016? Will Europe outperform the US again like it did last year? What about the primary bond market? The start of the New Year always brings with it a host of questions from our clients. Here’s my take on what this year could hold for the asset class.
The divergence between European and US high yield is likely to continue. In December, the Federal Reserve hiked interest rates for the first time since 2006 on the back of improving economic and employment data. By contrast, the European Central Bank (ECB) is continuing to ease monetary policy through large-scale asset purchases. Europe is at an earlier, more credit-friendly phase of the economic cycle than the US, which could feed through into better earnings going forward.
On top of this, default rates are expected to remain low in Europe, while in the US they are starting to pick up, particularly in energy names that have been pressured by the sharp decline in oil and commodity prices. As I have written before, US high yield has much larger exposure to energy and metals and mining sectors than Europe. In all, fundamentals and technicals remain stronger in Europe; although this is reflected in prices with yields, on average, trading much lower than their US counterparts.
On the primary market front, after a subdued end to 2015, I expect new issuance to pick up. Some key event risks have now passed with the Fed having raised interest rates last month and the ECB extending quantitative easing. Still, concerns over China and oil and commodity prices linger, which is causing turbulence across risk markets. Against this backdrop, I expect potential issuers to be cautious on the timing of bringing new deals to the market. And when they do, the conditions for issuing will look quite different to those they faced this time last year, with spreads wider and yields higher.
As in 2015, volatility looks set to remain elevated this year. It remains unclear how severe China’s slowdown will be, and how it will impact Asia and the broader global economy. Although European High Yield companies tend to do most of their business in Europe, the asset class is vulnerable to broader risk sentiment. From a portfolio perspective, we will continue to focus on bottom-up credit research this year to identify the best opportunities for our clients and help to protect them against external risks.
2016-GL-3256
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