With the European Central Bank likely to unveil plans to taper its asset purchases this week, bond markets might have been expected to suffer. While government bond yields have indeed risen – 10-year Bund yields are up 12 basis points in the last week – yields on the riskiest corporate debt have been moving in the opposite direction.
Since the start of October, the BAML Euro High Yield Index's effective yield has fallen from 2.39% to 2.17% – and is now virtually the same as similar duration US five-year Treasuries, which offer 2.07%. (Effective yield takes account of issuer provisions such as the ability to redeem the bonds before maturity).
This anomaly partly reflects strong demand for high yield, low levels of issuance, and improving credit quality shrinking the universe of sub-investment grade bonds. But, despite these supportive factors, we believe European high yield is unattractive at current levels:
Yields are at all-time lows. 20% of the European high-yield index offers an effective yield of less than 1%. Some high yield bonds, which are likely to be redeemed, even offer a negative yield.
- This spread between European high yield and Bunds, at 233bps, is the lowest in the post-financial crisis period.
- Once underway, we believe ECB tapering should have an impact, triggering spread widening and greater volatility in the high yield asset class.
So while the healthy European growth outlook and corporate fundamentals suggest no cause for concern, we believe Euro high yield bonds are expensive and expect them to underperform a mix of global equities and US high grade bonds over the next six months.
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