BofAML _ The European Credit Strategist: QE’s merry-go-round

Redacción - Miercoles, 21 de Septiembre

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The European Credit Strategist: QE’s merry-go-round
•   QE-eligible corporate bond spreads have stalled lately, but non-eligible spreads have continued to tighten.
•   Given tighter US credit spreads and a more -ve EUR-USD basis swap, US investors should find 1-5yr Euro credit attractive.
•   We expect US investors would buy Reverse Yankees and consumers, banks and autos, in Europe.

Two's a crowd

We think there is already clear evidence across European credit that investors are being crowded into higher-beta parts of the market. Spread tightening for eligible CSPP and CBPS names has stalled recently. Yet, spreads for non-eligible creditshave continued to tighten significantly. But we think that issuance has to increase in non-eligible sectors to facilitate this new investor demand. If not, our concern is that crowding runs the risk of making parts of the credit market unstable. Note that while the European high-yield market has benefited from a reach for yield post QE, high-yield bond supply is 35% down year-over-year, as cov-lite loan financing grows in popularity. Since Draghi's "disappointment" at the last ECB meeting, high-yield spreads have suffered much more than investment-grade spreads.

QE's merry-go-round

US credit has been a great beneficiary of Draghi's QE. Euro-denominated investors have reallocated towards $-denominated corporate bonds, helping tighten US spreads. But the EUR-USD cross-currency basis swap has also become more negative this year, in part we believe a reflection of ECB QE (dollar funding becomes scarcer, relative to Euros). But as we highlighted in Friday'sCredit Market Strategist, the upshot of this is that 1-5yr Euro IG credit is now looking attractive from the perspective of a currency-hedgedUS investor. And 1-5yr bonds are still nearly 50% of the Euro IG market. The irony is that with ECB monetary policy having driven European credit investors into the US corporate bond market, the groundwork has now been laid for US credit investors to buy more Euro credit - a market where over 20% of bonds are negative yielding.

Are we all just currency investors now?

If US investors ramp up their buying of Euro-denominated credit,then it would be a bullish technical for Euro spreads.But underlying this is the notion that global credit flows are increasingly becoming "touristy" and driven by currency considerations, rather than credit ones. Changes in basis swap spreadscan therefore have profound implications for credit demand in the future. 

What might US credit investors buy in Europe?

US investors will likely keep to a strong home bias with their Euro credit purchases. This bodes well for Reverse Yankees and for sectors such as consumers, banks and autos. For Reverse Yankees, spreads are now on top of Euro IG non-financials. But they have been tighter before (such as late 2014) and so we believe that there is scope for them to still outperform.

For sectors such as consumers, banks and autos, this is where European issuers have a big representation in the US credit market. Hence, US investor demand would likely gravitate to these sectors first in Europe.

See report (attached) for further information.

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