Can European Credit Ride Out the Storm?

As Europe struggles with war, costly energy, record inflation and slowing growth, it’s no surprise that European corporate credit is out of favor. But in our view, bond prices already reflect a lot of bad news. Has the time to buy arrived?

In the face of geopolitical and economic storms, European investment-grade and high-yield credit have both slumped this year, leaving valuations cheaper than at any time since the global financial crisis (GFC) and yields higher than US equivalents. But with the European Central Bank (ECB) set to continue hiking rates, and with a tough winter in store, most investors remain wary. Even so, at current yield levels it’s important to see the issues in context.

European Credit Has Solid Fundamentals

European corporates are fundamentally in good shape. They’ve bounced back from the COVID emergency period, reducing their leverage and restoring margins (Display, below). So at this point, both their balance sheets and pricing power seem resilient.

Cash-to-debt levels are high right now, a further indicator that European corporates are prepared to weather another challenging period. Of course, if European economies enter a recession, which seems likely, we expect those metrics to weaken, but the starting point is certainly strong.

Technical factors in the market are still modestly supportive. The ECB has ended its major bond-buying programs, but is still reinvesting the proceeds from its investment-grade holdings, providing some continuing support for this part of the market. Meanwhile, euro credit issuance has fallen away sharply, keeping supply balanced with demand.