European corporate credit cash bonds (both investment grade and high yield) outperformed the US during the February and March twin oil-virus shock. However, since March 23—when the US Federal Reserve (Fed) announced its corporate bond buying programs—US cash bonds have posted a stronger recovery relative to Europe, despite elevated new US bond issuance. This implies that prior to the Fed’s policy announcement, illiquidity and outflows had led to a sharper widening in US credit spreads relative to Europe. This is not too surprising, given the European Central Bank (ECB) was purchasing European bonds pre-virus, thereby supporting liquidity.
Among credit derivatives, European investment grade (iTraxx Main) has slightly outperformed the US (CDX IG) since credit markets bottomed in late March. European derivatives outperformance has been greater in high yield (as reflected by iTraxx Crossover performance relative to CDX HY). This is likely due to higher default activity among US high yield issuers, with seven defaulting since March; this contrasts with no default-related losses in Europe. A higher exposure to energy in the US also explains divergence between European and US high yield credit derivatives.
Where do we go from here?
Looking ahead, the policy environment in both the US and Europe remains supportive, with the ECB buying bonds through to 2021 and the Fed recently extending its credit facilities to year-end. That said, we think variation in underlying credit fundamentals will begin to play a more prominent role, particularly in the US, once the liquidity tailwind from central bank policies is largely priced.
Opportunities in European corporate credit
The economic recovery in Europe is more advanced than the US due to better coronavirus suppression. In addition, a recent agreement on the EU Recovery Fund raises hopes for further fiscal integration and as mentioned above, ECB policy remains ultra-easy. This macro backdrop is supportive for European corporate credit issuers. Moreover, European investment grade corporate credit continues to offer attractive yields relative to sovereign bonds in the region which remain bounded by a negative ECB policy rate.
Source: Macrobond, GSAM, Bloomberg Barclays European Corporate Index. As of 29 July 2020. Effective index duration is 5.9 years.