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Borrowing costs for European companies have fallen to a two-year low against benchmark bonds, as shifting expectations on interest rates narrows the gap with their US counterparts
The average European investment-grade spread — the premium paid by companies to borrow over equivalent German government bond yields — has dropped from 1.36 percentage points to 1.15 percentage points this year, according to Ice BofA data.
By contrast the premium paid by American borrowers to issue new debt over the equivalent Treasury yield is also hovering around a two-year low — but its decline has been steadier, down just 0.07 percentage points this year.
The shifting moves have taken the difference between the two regions to just 0.18 percentage points, its narrowest level in 10 months.
Market participants said that this convergence reflected, in part, rising optimism about the state of the eurozone economy — allowing credit spreads in the region to catch up with the rapid tightening that had taken place previously in the US.
“Over the past six months the eurozone outlook has improved considerably,” said Tim Murray, multi-asset strategist at T Rowe Price. While “there is still plenty of doubt about how strong and durable the eurozone recovery will be . . . the recession risk has faded considerably”.
Markets have also been pricing in fewer interest rate cuts on both sides of the Atlantic, with the European Central Bank more likely to cut first. Most traders are now expecting the ECB to make between three and four cuts this year, starting in June. The Fed is expected to do the same, but starting in July.
That has also fuelled spread tightening across the board and increased the appeal of European bonds with relatively high yields.
“Last year US credit did outperform — European credit did OK, but not to the same degree,” said Mohit Mittal, chief investment officer of core strategies at Pimco. “It wasn’t that European credit was severely dislocated versus the US,” said Mittal. “It’s more that November and December were very strong months in the US, and European credit is playing catch-up this year.”
Kristina Hooper, chief global market strategist at Invesco, said “it’s only normal that investors chasing yield would flock to European investment-grade bonds and pull down spreads”.
Market participants added that a fresh deluge of dollar-denominated bond issuance has also acted as a temporary brake on US spreads. Dollar-denominated borrowing has blasted through records in the early months of 2024, with year-to-date investment-grade bond sales reaching $473bn — the highest figure since at least 1990, according to LSEG data.
By comparison, euro-denominated issuance stands at a smaller $252bn year to date, lower than the same period in 2023.
Christian Hantel, portfolio manager at Vontobel Asset Management, said his team had been allocating more credit exposure towards Europe this year, funded partly by cash generated from the sale of US corporate bonds that had performed well.
Still, he and other market participants pointed to persistent concerns over the health of the European economy — highlighting the potential for bonds to be issued with a “too tight” spread, failing to price in risks accurately.
Spreads have also tightened this year between US and European junk bonds, with the gap between the two metrics sliding from 0.57 percentage points in late 2023 to just 0.18 percentage points on Tuesday, their narrowest gulf in three weeks.
“It makes sense that investment-grade has been converging” because of a tendency to move “up in quality when there’s a slowdown,” said Torsten Slok, chief economist at Apollo.
“But where there’s more debate is about why European high-yield has been doing better. The European outlook continues to look quite weak,” he said.
