European High Yield - September

Could Supply Derail Performance in European High Yield Over The Next Few Months?

Events in China led the European high yield bond market to generate negative returns in August. The yuan devaluation caught markets completely off guard and fueled fears that the world’s second-largest economy could be heading for a sharp slowdown. The ripple effects were felt far and wide, with European high yield impacted through the rise in risk aversion. This caused spreads to widen, although to a lesser extent than their U.S. counterpart, which once again suffered more because of its higher exposure to the energy and metals and mining sectors.

On the primary market front, the volatility stemming from escalating China concerns ensured that there was next to nothing in new bond issuance over the month. August is traditionally a low month for new bond supply, but with China concerns lingering how will this influence the pipeline for the rest of 2015?

As a starting point, around €5 billion in bonds are set to mature by the end of 2015 (see Figure 1). However, this doesn’t tell the full story as it does not include the potential early refinancing of a number of issues with early call date structures. As overall interest rates remain low by historical standards, we believe this could be the start of a new issuance trend in European high yield where not only maturing bonds get refinanced, but also ones with call structures.

In terms of timing, there are some external risk events that could keep potential borrowers on the sidelines for longer than usual post summer. We have new elections in Greece, and the Federal Reserve meets September 16-17 to decide whether to raise U.S. interest rates for the first time since 2006. Both these events, particularly the latter, have potential to impact risk markets and cause volatility. But once they pass, we would expect the primary market to reopen meaningfully.

When the market eventually comes back to life, it is fair to say that the conditions for issuing will look quite different from what borrowers faced in the first quarter of 2015. The weakness in August means spreads are wider, yields are higher and for the first time since 2012, the average price of a bond is now below par. When combined with solid fundamentals, the European Central Bank’s accommodative monetary policy stance, and continued improvement in the eurozone economy, I feel that the value opportunity in the asset class stands out.

Figure 1

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