Fitch warns of rising risks for European high-yield bond market

Record high prices combined with more risky corporate bond supply is creating “increasing uncertainty” and raising the chances of a sharp turnround in the European high-yield credit market, Fitch Ratings has warned.

Yields on the most popular benchmark for European junk bonds fell below two per cent for the first time ever last week, but Fitch warned that recent market calm and the distorting impact of central bank monetary policy “obscure the true risk-return dynamics faced by investors”.

The ratings agency said the proportion of newly-issued bonds with the lowest credit ratings – CCC+ or below – has risen to its highest level since 2013, when average yields were more than five per cent. Higher yields reflect lower prices.

Investors have already voiced concerns about excessive risk-taking, but many have continued to buy the riskier bonds due to a shortage of alternatives. A resurgent loan market has reduced the number of new high-yield bond issues, while the European Central Bank’s bond-purchasing programme has pushed investors who traditionally focused on investment-grade bonds to buy lower-rated debt.

The ECB announced last month that it will cut back on its quantitative easing programme from the start of next year, but it has stressed that it will continue to buy “sizable quantities” of investment-grade corporate debt. In a recent report, Pictet Wealth Management’s Frederik Ducrozet predicted that “corporate debt purchases in particular will not be scaled down to the same extent as public debt”.

Fitch said:

The ECB’s bond purchases have anchored the low-volatilitiy conditions and sustained record low yields; a situation that is likely to be maintained through most of 2018 despite a scaled-down but extended bond buying programme. However, record low spread volatility juxtaposed against riskier bond supply increases the risk of an inflection point later in 2018, despite robust technical support.