Credit spreads in the euro investment credit (IG) market have been remarkably stable in recent months, with an average option-adjusted spread of 84 basis points (+/-2bps) going all the way back to mid-April 2021. The absence of volatility has come despite the proliferation of the Delta variant and heightened concerns around inflation. The U.S. IG credit market, on the other hand, has exhibited noticeably higher relative sensitivity to macro sentiment and has underperformed euro-denominated counterparts as a result.
Occasionally, investors can be guilty of trying to form narratives that fit the facts of short-term market moves when sometimes the best explanation is simply that there’s been more buyers than sellers, or vice versa. So, is there anything material we can say about the outperformance of euro IG credit?
- Relative to market size, there has been a far greater bond supply deficit in the euro market than in the U.S. Aggregating net new issuance, fund flows, coupon reinvestments and the ECB’s corporate bond-buying program, we estimated a net supply deficit of €1 – 3 billion per month through the summer. In essence, there were more buyers than sellers, which echoes our original point on short-run market dynamics. Although the Federal Reserve had previously maintained the option of large-scale corporate bond purchases, very few were executed, and now broader tapering is on the way.
- Another reasonable factor could lie in the relative beta of the two markets. Although the duration of euro IG credit has increased in recent times, it is still approximately three years shorter than the U.S. This naturally leads to diverging total returns when we see interest rate volatility coincide with spread volatility. Factor in the greater market value share of higher-beta sectors such as energy and technology in the U.S., and you can see why we need to consider the composition of the two markets when thinking about relative performance.
No matter the dominant driver of returns, we are left with a euro IG credit market at historically tight valuations with little volatility despite broader macro uncertainties. That said, there are pockets of value, and we will continue to focus our attention on stress-testing company fundamentals under various scenarios and allocating capital to those securities with the highest margins of safety.