What are the current opportunities in euro credit?

Key points: 

• Current yield levels are attractive compared to historical levels
• Sectors to focus on in investment grade credits
• Why the euro high yield default cycle should remain contained

After a decade of low-yield environment, fixed income investors are back in a positive mood. First, yields started the year at their highest level, and valuations, together with liquidity, will be the key positive features of fixed income this year. Second, the central bank bull market cycle appears to be behind us. And third, the stable performance observed at the end of 2022 is helping to restore investors' confidence.

Yield levels are attractive

One of the key advantages of investing in fixed income in 2023 is that new bonds are paying coupons which are much higher compared to one year ago. The average yield of the European credit market is now close to 4.0% for Investment Grade (7.1% for High Yield) compared to 0.9% (3.6% for High Yield) one year ago.¹ We see this complete revolution in fixed income as creating potentially attractive opportunities for long-term investors.

Investment grade credit fundamentals are strong

In Euro Investment Grade credit markets, we expect fundamentals to remain resilient. Companies have reported strong balance sheets and high liquidity levels after benefitting from cheap debt refinancing over the past few years.

In our opinion, there are a few sectors which are worth highlighting. In financials, the picture remains sound for banks as they benefit from higher net interest income which should offset the higher cost of risk in the coming quarters. In real estate, despite the leverage and refinancing requirements, the massive readjustment in valuations throughout 2022 represents an opportunity to add risk selectively in issuers where we have strong conviction.

High yield offers some opportunities

In European High Yield markets, we have a preference for BB and selective B issuers as they tend to have decent fundamentals which should result in manageable credit risk. In this market segment, companies are well positioned as they were active in refinancing their capital restructure in 2020 and 2021. With the likelihood of a recession on the horizon, investors may want to consider short-dated bonds as they are less sensitive to interest rate risk.

Overall, good quality short duration high yield remains a comfortable place to be invested in within the euro credit universe however maintaining an active approach and focus on credit selection and sector allocation will be key.

Euro Credit: a significant potential to outperform in 2023

We entered 2023 with some concerns about equity valuations, with potential headwinds to earnings being revised downward due to the impact of inflation and slowing growth on companies. On the other hand, the restrictive policies of the major central banks, primarily concerned about bringing down inflation, are driving up yields in some bond sectors.

The road for credit markets, may remain bumpy from here as we do not rule out volatility episodes in the coming quarters. However, the deceleration should be gradual, and we do not expect a massive repricing in bond markets.  We believe that 2023 will be the year of Fixed Income, particularly in Investment Grade and High Yield markets offering attractive yields, in a market environment driven by resilient macro fundamentals and stabilising monetary policies.