European credit spreads, that is the difference between the yield on European corporate bonds and European sovereign bonds, have continued to tighten over recent weeks continuing a trend seen throughout the year. Non-investment grade (HY) debt has tightened by circa 100bps compared to investment grade (IG) debt which has tightened by circa 37bp.
In fact, as at the time of writing, European IG spreads are trading at the 26th percentile based on data compiled over the last five years while European HY spreads are trading at the 15th percentile based on data over the same period.
The tightening of spreads over recent weeks was largely driven by political factors, particularly the US presidential election as Trump’s policies are viewed by many economists to be anti-growth given the implications of potential tariff hikes but also due to other factors such as supply and demand dynamics within the European credit market.
Corporate earnings, monetary policy, and macroeconomic data have had a lesser influence on European spreads.
While third-quarter earnings were mostly favourable, the focus has mainly been on macroeconomic data and central bank decisions. The European Central Bank cut rates by another 25 basis points this month, which was widely expected and priced in, and which generally benefits fixed income assets.
This, together with corporate bond supply dynamics, has created a supportive technical environment for credit markets. Lower financing rates prompted issuers to come to market, while investors sought to lock in higher yields, particularly for longer-term maturities as per fund flow data.
Primary market issuance within the European bond market in 2024 was stronger when compared to 2023, due to the earlier onset of the rate-cutting cycle in Europe.
European IG issuance has risen to €455.7 billion, on a year-to-date basis, from €429 billion, while European HY issuance surged to €87 billion from €44 billion during the same period. European fund flows, which is another important technical dynamic that effects the European corporate bond market, experienced a substantial increase in demand, particularly for the HY segment as investors sought to lock-in higher yields given expectations of more rate cuts by the European Central Bank in 2025.
In 2025, according to analysts at Goldman Sachs, European spreads are expected to widen marginally but remain somewhat range bound.
In fact, European IG spreads are expected to rise by 12 basis points from their current levels while European HY spreads are expected to widen by 30bp.
Supply technicals are expected to continue to support the European credit market with lower rates encouraging issuers to refinance existing debt at lower rates as EUR IG supply is expected to decline marginally while HY supply is projected to fall by 10% due to weaker economic growth in the eurozone.
The European HY default rate is expected to climb marginally in 2025 from its current level.
Analysts expect default rates, which are already below the historical average, to likely remain at similar levels and are forecasting that the European HY default rate will move towards 3.0% by year-end 2025 from their current levels of 2.9%.
The default rate is unlikely to have an impact on the market performance as most defaults will likely be skewed towards small firms and distressed exchanges.
The impact of Trump’s policies on the European credit market remains unclear at this point in time as the President-elect is yet to take office with more focus being given to the current political turmoil within Europe’s two largest economies, Germany and France, and the benign economic growth prospects for the bloc.
In 2025, credit investors will likely focus on two factors. Firstly, the resilience of spreads and secondly the potential for renewed trade tensions which will undoubtedly impact European growth.
Despite the previously mentioned challenges, the ECB’s easing cycle and the strong technical support should limit the risk of significant widening in European corporate credit spreads in 2025.
Simon Gauci Borda is a fixed income research analyst.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.