Europe

Fixed income markets have experienced a reasonable correction over recent weeks and, for higher-yielding indices at least, their first negative period so far this year.

This looks to us like a buy-into-the-dip opportunity, but investors should be wary of taking on too much rate sensitivity as the move in risk-free curves is likely to persist until the rate hike cycle is actually on the way.

In the last month, global government bond curves have had a torrid time, with significant steepening seen across US Treasury, UK Gilt and German Bund yields.

Despite the impressive returns of Euro HY over the last year or so, the backdrop for the asset class continues to suggest there is more upside to come.

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There has been a lot of focus on the performance of the high yield markets since the start of the year, particularly in Q1 when many rates markets were selling off aggressively.

Having been at the heart of the GFC and then contributing to the Eurozone sovereign crisis, we have long argued the European banking sector would have to prove its newfound resilience to investors by successfully navigating a challenging period.

Primary deals launched in the European high yield market over the last two weeks have been diverse, and at times opportunistic.

In summary things are going quite well, and in this scenario a rise in government bond yields does not necessarily bring about a tightening of financial conditions.

Thursday’s ECB meeting left us in little doubt that we should expect some serious action in December, including the possibility of some new, as yet unused measures.

There are a number of countries in Europe where the banking sector remains very fragmented, and while a lot of work has been done in Spain with the mergers of multiple ‘cajas’ in the last few years, there is still scope for further consolidation.

The European high yield market has shown remarkable resilience in the face of what will likely go down as one of the sharpest and most severe recessions in history. The benchmark iTraxx Xover index (a widely used proxy for Euro HY credit risk) has tightened from an intraday high of 730bp in March to 342bp earlier this week, a retracement of almost 75% from the January lows of approximately 200bp.