BCA Research issued a warning about the outlook for European credit markets in a note on Tuesday, telling investors it is time to shift to a negative view of the asset class.
Analysts see European credit spreads as having “little room to narrow further from current levels,” leaving investors with little compensation for the growing risk of a recession later this year or in early 2025.
A key highlight of BCA Research is the impact of upcoming interest rate cuts by the European Central Bank.
In contrast to the typical market optimism associated with rate cuts, the Fed warned that these cuts “should not be viewed as credit positive” because they are likely to coincide with “darker days in markets ahead.”
Another crucial issue is the so-called “maturity wall,” referring to the large refinancing needs facing European companies in the short term.
According to the BCA, this would lead to higher borrowing costs, leading to “further deterioration in corporate balance sheets,” especially for high-yield issuers.
This deterioration, coupled with already strained balance sheets, is said to raise the prospect of further defaults in the coming months.
The US Federal Reserve’s models suggest that European high-yield credit is currently “expensive”, further supporting their negative outlook.
As a result, BCA Research recommends that investors prefer higher quality assets within fixed income portfolios and continue to favor sovereign bonds over corporate credit.
The US Federal Reserve concluded its report by saying: “The speculative default rate is expected to rise over the next 12 months. In fixed income portfolios, we continue to recommend investors to prefer sovereign bonds over credit.”
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