By Sandrine Soubeyran, Global Investment Research, FTSE Russell
2022 has been a volatile year for credit markets, but a closer inspection highlights some striking differences. Let’s take the EM, Euro and US high yield (HY) credit markets* as examples (Chart 1). Yields on EM HY reached much higher levels (close to 14% at its peak), and spiked much faster, than their Euro and US equivalents, which peaked at around 9% in Q4 2022 − a similar yield level for Euro HY, last seen after the initial Covid shock in 2020.
Unlike their EM HY peers, which did rise sharply after Russia invaded Ukraine in February 2022, yields on Euro HY showed little compelling evidence from the Ukraine shock, despite (a) the Eurozone being a substantial energy importer from Russia, and (b) the Eurozone being more exposed to disruption of trade flows, and geopolitical shocks in the region.
An alternative explanation for the differences between Euro and US HY yields in 2022 is the divergence in monetary policy regimes. The US Fed raised rates first in March 2022, just after the Ukraine shock, while the ECB only signalled tightening in June, when yield spreads versus US HY tightened sharply, as Chart 1 shows.
Performance setback in 2022
In return terms though, 2022 translated into one of the worst-performing years for corporate bonds, with double-digit losses mirroring those of equities (Table 1). However, it is also notable that investment grade (IG) corporates were weaker than HY credits, both in the US and Eurozone, unlike EM, where HY credits underperformed IG. This suggests that in 2022, the weak performance of credit could not be explained purely by risk aversion, since HY would have underperformed IG.
Different dynamics from HY for IG peers
For European investment grade credits, however, the dynamics differed somewhat from their sub-IG equivalents. Although they both incurred deep negative losses in 2022 (Table 1), the losses for Euro IG corporates were higher than their sub-IG peers due to their higher duration and closer correlation with rising ECB rates and Bund yields during the risk-on rallies (like in Q4 2022). Also, compared to Euro HY, the more modest initial response to the Ukraine shock from Euro investment grade corporates overall pointed to other factors. (Charts 2 and 3).
The dominant reason for the absence of an initial Ukraine shock in Euro IG corporates may have been the significant policy accommodation by the ECB still in place from the Covid shock. Another important point here was the type of assets purchased under the scheme. They included IG corporate debt (under the corporate sector purchase programme – CSPP) and euro-based public sector debt (public sector purchase programme – PSPP).
This QE kept Euro investment grade corporate bond yields ‘artificially’ stable for the duration of the programme until the end of June 2022. The evidence can be seen in Chart 4, where between February and June, Euro credit spreads rose gently, unlike the steeper jump in yields observed by their sub-IG peers. It was not until June when net APP ended and the ECB became increasingly hawkish, that spreads began to seriously widen.
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