Key points:
- Despite lingering inflation and heightened rate volatility, credit markets remained strong in the first four months of 2024.
- We believe the European credit cycle has been extended due to robust corporate and consumer balance sheets and changes in private sector behaviour.
- This means investors can continue to benefit from investment-grade credit's historically attractive yields.
- Nevertheless, we recognise potential risks to the cycle. An active, nimble and liquid approach, grounded in a thorough understanding of the cycle, should, in our view, position investors to manage risk better and take advantage of the current market and any dislocations as they arise.
Volatility in government bond markets, but calmness in credit markets
So far, 2024 has kept fixed income investors busy, with a blockbuster new issuance calendar, a pivot from the Bank of Japan and heightened geopolitical tensions in the Middle East all competing for the market's attention. Yet inflation stubbornly lingering above target — has remained the dominant theme, resulting in increased government bond yield volatility as the market has walked back expectations for central bank rate cuts throughout the remainder of the year.
Credit markets, however, paint a different picture. European credit markets have remained notably strong. Spreads have tightened, supported by robust corporate balance sheets, a resilient consumer and favourable market technicals. Yet despite tightening, European investment-grade credit continues to look appealing, providing historically high all-in yields of 3.9%, allowing investors to benefit from attractive income without the need to take excessive risks. What do investors need to know about opportunities in European credit and what could the rest of the year hold?
Understanding the cycle
Understanding the credit cycle — the recurring phases of expansion and contraction in the availability of credit — is a crucial ingredient for successfully managing European investment-grade credit portfolios. Specifically, by anticipating changes in the cycle and dynamically managing overall credit exposure, we aim to participate in the upside while preserving capital on the downside. Put simply, there are times we want to have more exposure to credit, and times we want to have less. Through our active approach to managing credit risk, we seek to insulate clients from the volatility of the credit cycle and aim to provide them with a smooth, consistent return stream of outperformance.
We seek to understand the cycle by paying close attention to the strength of corporate balance sheets, the resilience of the consumer and the speed at which changes in interest rates are transmitting through to the economy. Despite one of the most aggressive rate-hiking cycles in history, European Central Bank (ECB) policy appears to be working, albeit with a longer lag than in previous cycles. Combined with rebounding growth, we believe that credit should remain supported in the near term. In this article we identify three potential drivers of an extension to the credit cycle.
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Disclaimer
For professional, institutional and accredited investors only. Capital at risk. The views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. While any third-party data used is considered reliable, its accuracy is not guaranteed. This commentary is provided for informational purposes only and should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell or the solicitation of an offer to purchase shares or other securities. Holdings vary and there is no guarantee that a portfolio has held or will continue hold any of the securities listed. Wellington assumes no duty to update any information in this material in the event that such information changes.
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