US and euro investment-grade credits: similar, but different
We have moved up our stance on euro investment-grade credits to neutral, believing they have better potential than their US peers.
US and euro investment grade (IG) indices have posted solid returns year-to-date thanks to a rally in credit spreads and sovereign yields linked to the dovish turn taken by some large central banks.
We have turned neutral from underweight on euro IG credit, while retaining our underweight stance on US IG credit. First, euro IG offers an attractive yield pick-up compared with mostly negative core euro sovereign yields. Second, the median leverage ratio of non-financial public companies on the euro credit index seems to be trending down across all ratings grades. In the US, by contrast, only the riskiest segment (high yield (HY)) and the safest ones (bonds rated A and above) have commenced a timid deleveraging, while leverage keeps rising for BBB-rated bonds, which now make up 50% of the US IG space. The fact that euro IG posts a lower median leverage ratio than its US counterpart for a similar level of spread makes the former relatively more attractive when one looks at the spread per turn of leverage, a key risk-reward metric.
Individual credit stories and low profitability could remain a concern for the euro area banking sector—but, along with the growing share of ‘BBB’ rated issuers (the bottom of the investment grade ratings scale), it seems that this concern has been put on the back-burner by markets and may not resurface this year unless the pick-up in the global economy we expect in H2 fails to materialise.
Other concerns remain, however, be it a potential rise in gross issuance this year or scare liquidity. This lack of liquidity is mostly linked to changes in regulation and is likely to remain one of the main risks for credit in general. Should macroeconomic data deteriorate further, spreads could widen sharply again, especially for lower quality credit, in a rerun of the dismal conditions we saw at the end of 2018. For this reason, we are sticking to our recommendation to favour solid quality names within developed-market credit.