Europe

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.

Douglas Charleston examines the health of labour markets across key developed economies and why ABS investors shouldn’t fear the gradual removal of COVID related job support schemes

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.

Fixed income investors increasingly desire their investments to have a positive societal impact, but in the rush to scrutinise the Environmental, Social and Governance (ESG) credentials of government and corporate bond issuers, we believe the natural ESG advantages of asset-backed securities (ABS) have so far been overlooked.

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.

Having fallen behind other markets in the post-COVID rally due to a lack of direct central bank support, we believe European ABS is set to outperform other parts of fixed income in the coming months as supply wanes and investors look to pick up on what we think could be a compelling relative value opportunity.

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.

Markets opened today to the news that German Chancellor, Angela Merkel, and French President, Emmanuel Macron, had reached an agreement to support the launch of a €500bn support package to aid the European Union’s recovery from the coronavirus outbreak, which has devastated large parts of the continent.