"European credit: divergence between the bond and credit derivatives markets"
From Bond Vigilantes:
There is a general belief in markets that the economic cycle follows
the US – and therefore that you can’t have a recession in a developed
market without a US recession first. Yes, the US economy is the biggest
out there, and with general market sentiment being that we are late
cycle it is understandable that everyone’s focus is on the US data and
its flattening yield curve.
But what has really been grabbing headlines in recent months has been
the Eurozone economy, where data continues to disappoint: real growth
is at its lowest since the sovereign debt crisis, Italy is now
officially in recession after posting two consecutive quarters of
negative growth, while Germany is on the borderline having just posted
Q4 growth of zero after a negative Q3 print.
Only time will tell whether the Eurozone goes into recession but if
we do have a recession in Europe, while European credit will likely
underperform, the magnitude of this underperformance probably won’t be
as extreme as that which we saw in the sovereign debt crisis of
2011-12. This is not only because the ECB remains a significant
investor in the market (through its QE investments), but also because
the composition of the market has changed drastically over time, making
the European corporate bond index more diversified.
Take a look at the charts below: on the left-hand side you can see
two ways in which the European investment grade index has changed since
2010. Firstly, the financials exposure of the index has decreased
considerably, from 53 per cent in 2010 to 35 per cent today. The
financial sector is generally one of the most impacted sectors during a
downturn, as we saw in the 2011-12 European sovereign debt crisis.
Secondly, the regional concentration of the index has decreased, from 85
per cent Europe in 2010 to 76 per cent today. This exposure has been
taken up mainly by the US and emerging markets, making the index more
geographically diversified.
It is also interesting to compare this to the Euro credit derivative market (on the right-hand side)....
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