European markets have been on a wild ride

Good morning. This is Harriet Clarfelt, standing in for Mr Armstrong as he takes a much-deserved day off. Complaints to him, any other comments to me, please: harriet.clarfelt@ft.com.

I myself was on holiday just last week; something that Rob perhaps took into consideration as he sought out a well-rested colleague, fresh from sunnier climes.

Little chance on the weather front, given that I ventured back to my hometown, London. But, usefully, a brief hop across the continent to Austria and France did prompt me to take a closer look at European markets. (And dumplings, schnitzel and many other starchy food products . . .)

Which leads me on to . . . OATs

French government bonds, aka OATs (short for obligations assimilables du Trésor), have had a volatile time since President Emmanuel Macron called snap parliamentary elections two Sundays ago.

The 10-year French bond yield surged last week as the price of the instrument fell, and the spread or gap between French and German benchmark yields — seen as a barometer for the risk of holding France’s debt — rose to more than 0.8 percentage points last Friday, its widest level since 2017.

As has been well-documented by my colleagues, other French markets have also come under pressure over the past fortnight as investors digested the possibility of a far-right government with big spending plans, and the formation of a leftwing bloc that could erase Macron’s centrist alliance.

Last week marked the worst decline for the Cac 40 index since 2022, and — as I’ll discuss — European corporate borrowing premiums leapt higher.

So: 1) What do those higher premiums mean for companies with euro-denominated debt obligations? and 2) Could this bout of volatility present an opportunity for would-be investors?

My answers, in brief, are: 1) Companies tapping the European investment-grade bond market now have to pay the highest premium in several weeks to issue debt — not ideal if you’d been planning to get a big deal away any time soon.

And 2) Maybe — if you believe that any further turmoil will be shortlived beyond the two-round French political contest taking place on June 30 and July 7. Although, of course, individual credit selection is crucial — and then there’s the fact that France is far from the only country holding elections this year.

First, some numbers. The average euro investment-grade spread — the premium paid by borrowers to issue debt over equivalent German Bund yields — sits at roughly 1.2 percentage points, having last week touched its highest point since February.

That’s still much lower than it was six months ago, but considerably higher than early June’s level of just 1.06 percentage points.

The average high-yield, or “junk” spread, is also much lower than it was last year, but has climbed sharply from 3.21 percentage points to just under 3.5 percentage points this month, according to Ice BofA data.

For Goldman Sachs’ chief credit strategist Lotfi Karoui, such moves reflect “uncertainty [about] the outcome over the election, and the lack of clarity that investors have about the economic agenda of various players”.

True, US corporate bond spreads have also expanded in June. But the move has been less pronounced than across the pond — and that lack of direct correlation means the gap between the two regions’ investment-grade spreads reached its widest level in four months earlier this week.

So, some might be tempted to hang out temporarily in the dollar market until volatility calms down in Europe. In a sign of the US market’s openness to new issuance — and persistent demand from investors — a number of big deals have landed this week, with Home Depot completing a nine-part $10bn bond sale on Monday.

But could we be witnessing more of a lasting shift? There’s an argument that spreads were simply too narrow for the risk they were supposed to be reflecting before, and it was about time for a widening. Indeed, Man Group’s Mike Scott notes: “France [has] provided a catalyst for the reassessment of risk — which had not been appropriately priced.”

Analysts at Deutsche Bank wrote this week that they’re “still comfortable with credit on an absolute basis” and that “the odds of a European systemic political shock are overstated”. But they added that European credit should now trade with a wider spread to US credit, “both on political fears, and an ECB seemingly hesitant to diverge from the Fed” with regards to interest rate cuts.

In fairness, euro credit spreads have actually edged a little lower from where they were last week. (Choosing to write about a topic, and then desperately watching the trend start to unwind, is an occupational hazard of a markets journalist.)

This might be an indication that concerns are beginning to ease already.

And if you believe that markets’ worst political fears are unlikely to be realised, and that volatility won’t last for too long, then this could be a nice moment to scoop up some slightly cheaper debt.

“People were complaining about tight credit spreads,” notes Vontobel’s Christian Hantel. “If you look now at the widening in Europe — and assuming that the damage on the political landscape in France could hopefully be limited — it could be an interesting entry opportunity for investors.”

JPMorgan analysts concur. “In our view, while there are many risks, this situation ultimately provides a buying opportunity,” they wrote last Friday, noting that “European investors are no stranger to political risk.” Meanwhile, “technicals” — namely investor inflows into euro high-grade bond funds — have remained “extremely strong”.

My view? Opportunistic buying on the assumption that volatility will continue to ease still requires a hefty dose of judiciousness about individual companies’ prospects — and credit quality — in any political scenario.

Not to mention a recognition of the wider international context we find ourselves in this year, with UK elections landing between France’s two rounds, and of course, the US election looming in November.

Then there’s the question of when and how far central banks will cut rates . . . and the debate about the broader economic outlook.

For Man Group’s Scott, “volatility is here to stay” as a number of elections play out — but as far as high-yield credit goes, “the bigger thing in general is going to be the growth backdrop”.

Defaults diverge

The latest monthly corporate default reports are out, and — contrary to some of the fears being espoused in the past year, things don’t look too bad. But they don’t look too good either.

Global defaults totalled 14 in May, according to S&P Global Ratings, taking the year-to-date total to 69. That’s two fewer than the comparative period in 2023. But as S&P says, it’s still “well above” the five-year average.

May’s default numbers also highlight the theme of regional divergence. US defaults last month were higher than those in Europe — at nine versus four. But while US defaults actually dropped month-on-month, Europe’s defaults held steady, keeping the region’s year-to-date tally at its highest since 2008, at 19.

Moreover 11 of those European defaults were so-called distressed exchanges.

This type of debt-exchange transaction can help companies (and their private-equity backers) avoid expensive bankruptcy proceedings — though our previous reporting indicates that distressed exchanges can occasionally just kick the can down the road towards the courtroom, anyway.

S&P and Moody’s do expect default rates to trend lower over the next 12 months. But that’s contingent to some extent on the path of interest rates, growth and geopolitical developments.

Weaker corporate borrowers — and particularly leveraged loan issuers, whose debt costs float up and down with prevailing interest rates — will be keenly searching for signs of relief on the horizon. The trouble is that central banks are unlikely to quicken the pace of said relief unless they’re facing sharply slowing growth.

And that environment wouldn’t be great for highly-indebted, low-quality companies either.

One good read

Hertz raises fresh cash for breathing room.

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