ECB tightening, politically-led volatility or improving fundamentals? What factor is likely to shape the case for European high yield in the year ahead.
T. Rowe Price’s Mike Della Vedova, who is Citywire + rated, believes no single factor can be focused on as there is an array of issues at play which need to be assessed.
Here Della Vedova, who runs several funds at the firm, including the $1.6 billion T Rowe Global High Yield Bond fund, names five key points investors should be focused on for 2018.
#1 Technicals likely to remain positive
Della Vedova said the default rate should remain lower than its historical average in Europe and could possibly fall below 2%.
‘Echoing last year, while gross supply might be high, we anticipate net new bond issuance will remain relatively subdued as refinancing is likely to dominate use of proceeds again.
'Flows are more difficult to forecast and are expected to be driven by the external environment and broad sentiment toward risk markets.’
#2 Tapering in focus
With 4.5% allocated to high yield bonds - mainly BBB-rated debt - Vedova said strong fundamentals underpin the European economy.
He said positive growth momentum should continue this year, which would provide support for high yield companies.
‘While the ECB is reducing the pace of its bond-buying from this month, its path to normalization is likely to be slow and cautious.
‘This should ensure that a key support factor for the asset class remains in place for the foreseeable future. Nonetheless, questions about what the ECB will do next will increase as the year progresses, particularly if inflation pressures pick up.’
#3 Moderate spread tightening
Della Vedova said the widening in European high yield over the last two months of 2017 leaves room for some moderate spread tightening to occur in the first half of the year.
‘From a yield perspective, we kick off the New Year with the average yield for the asset class below 3%. Viewed in isolation, this is far from attractive.
‘However, if the technical and fundamental factors that underpin European high yield remain robust, demand from investors could continue.
'For European-domiciled investors, in particular, relative value in the asset class versus eurozone government bonds remains attractive – as a large number of government bonds in the region continue to trade with negative yields.’
#4 Favorable backdrop for new issuance
With low financing costs and ongoing demand for yield providing a favorable backdrop for issuers to bring new deals to the primary market in early 2018, Della Vedova said the team anticipates robust results.
‘As the year progresses, if credit markets stay benign, there is a risk we could see more aggressive deals being brought to test the market.’
#5 Politics and tightening
With several major central banks all pivoting toward less accommodative policy at the same time, it is not clear how global growth and liquidity might be affected.
However, looking at the political world, Della Vedova said high yield investors need to be aware of macro-led shocks and prepare accordingly.
‘While concerns over disruption by anti-establishment forces have receded in Europe, we believe risks remain, with Italy due to hold a general election on March 4. Negotiations over the UK’s exit from the European Union will also continue.
‘Any one of these factors has the potential to trigger bouts of volatility and broad risk-off moves in financial markets. As such, given its sensitivity to broad risk sentiment, European high yield would be vulnerable in such periods.’
Over the three years to the end of December 2017, the T Rowe Global High Yield Bond fund returned 21.74% in US dollar terms. This compares with a 17.23% rise by its Citywire-assigned benchmark the ICE BofAML Global High Yield TR EUR, over the same time period.