Finding new opportunity in European investment grade credit

01

Geopolitical developments

Following years in which the cost of funding seemed only to be rising, and macroeconomic and geopolitical developments had a dampening effect on capital markets, players in most sectors are now relishing a more positive mood and a rise in bond market activity. This is despite interest rates remaining high, the wars in Ukraine and Gaza showing no sign of ending soon, and a spate of elections threatening to change the political landscape.

The year kicked off with highly favourable conditions in January. Debt issuers were quick to take advantage of a conducive market characterised by strong investor appetite and ample liquidity. The result was record volumes of both US and European investment grade (IG) bond issuances. This was a welcome change from the early days of the Ukraine war, when European corporate treasurers were unable to find suitable windows to access the market and faced the prospect of paying premiums of 10 to 20 basis points. At the same time investors, believing a reduction in interest rates was imminent, were opting to lock in their current coupons.

The investment environment in the first half was far from tranquil, but issuers sensed that the buy side was eager to put its money to work. Spreads were close to being as tight as they had ever been and coupons ticked upwards, causing an increase in cash inflows. Despite some redemptions at the asset class level, demand for IG bonds was sufficient to meet the surge in supply – with some issuers reporting significant oversubscription.

The question now is: will the second half of 2024 (and beyond) be as positive for capital markets as the first?

02

A stormy second half?

As 2023 drew to a close there were strong expectations of interest rates cuts by the US Federal Reserve. These have mostly failed to materialise as the Fed has kept rates steady while inflation continues to resist efforts to bring it within target levels, and some forecasters today are questioning whether it will cut them at all this year.

Looking at the latter half of the year, another factor causing uncertainty in the second half of the year is the US election. Analysts are also waiting to see what impact the shift in the balance of power in the European Parliament, as well as the dozens of other elections around the world, will have on markets.

03

Starting off strong  

Taking these developments into account, many commentators believe 2024 will be characterised by heavy front-loading.  

“The keyword many have adopted is ‘derisk’,” says Patrick Dupont-Liot, Managing Director, Debt Capital Markets, Standard Chartered. “The mindset has been, ‘If I need to get it done this year, I’d rather get most of it done before the summer, or even wait until next year’. This has been a very constructive shift in the market.”

The Council of Europe Development Bank, for instance, which planned to complete US$6 billion worth of social inclusion bond issuances this year, had successfully completed US$5 billion before the first half was done. Investors welcomed the early surge with higher coupons resulting in increased cash flows, allowing demand to match the rise in supply.

As Hussain Zaidi, Standard Chartered’s Global Head, Bond Syndicate, observes: “With many issuers close to meeting their funding targets for the year, there is a sense they can take their chips off the table, ride out the summer and not have to take too many risks in what they foresee will be a challenging macro-environment in the second half. A number of investors we have spoken to, are equally comfortable with issuers front-loading their funding requirements in 2024, as they agree market volatility may pick-up during Q4 2024.”

04

The market diversifies

Another notable feature of credit markets in 2024 is the rise in both geographic and investor diversification. Over the past couple of decades, risk-averse investors had a strong preference for euro- and dollar-based transactions. Shifts in geopolitical and macroeconomic circumstances caused coupons and (in some cases) spreads to rise, and the absolute yield on other currencies to grow. This translated into a greater appetite among investors for a diversity of currencies.

This trend is particularly apparent in Asia, where it has been gaining momentum in the past few years. Currencies such as the Hong Kong dollar are beginning to grow in popularity – with HKD-denominated debt issuances witnessing a 4.9% year-on-year increase in 2023 – while banks, fund managers and pension funds are making inroads into investor clubs traditionally dominated by central banks and other official institutions. There is a growing realisation that investors can stay within investment grade and still allocate to other asset classes – and achieve the higher coupons delivered by European and US IG bonds.

While the European IG business has tended to be US-centric, it is becoming more global. Asian and Middle Eastern investors and asset allocators who previously focused on emerging-market options are now looking more closely at European IG issuers. For example, the largest order for the luxury goods manufacturer LVMH’s latest issuance came out of Asia. Europe is also benefiting from changes in the insurance industry, with new regulations regarding bulk annuities driving up the demand by carriers and pension funds for European IG assets.

05

Tailwinds for Europe

Despite uncertainty about the second half of the year, the European IG market is enjoying significant tailwinds. As emerging market investors look to allocate in developed markets, Europe is flattered by a comparison with the US. Even setting aside the US election, credit fundamentals are solid, the ECB has started to cut rates and corporate leverage has begun to decline from its peak a few years ago.

Issuers may be forced to accept that the coupon levels of the past few years are no longer attainable. But if redemptions and a quiet second-half of the year lead to similar demand and liquidity in the new year to that which has already defined 2024, the European market can look forward to a productive 2025.

This article is based on a panel discussion at Standard Chartered’s Global Credit Markets Forum 2024 in Paris. Access panel recording here.