Fixed income

Developed market credit 2020 Outlook

We prefer euro high yield bonds to their US peers

Lauréline Renaud-Chatelain, Fixed Income Strategist

Developed market credit 2020 Outlook

There are no changes to our stance on developed market (DM) credits going into 2020. We expect low single-digit-to-flat total returns in 2020 from this source in local currency, except in US high yield (HY), where returns may be negative. As such, we foresee a more limited rise in euro HY credit spreads than in US ones, with the former rising from 341 bps (on December 6) to 400 by end 2020 in our central scenario (65% probability).

Neutral US and euro investment grade (IG) credit. Given our expectations of low US and euro GDP growth next year (1.3% and 1.0%, respectively), markets are likely to remain discriminatory, favouring robust companies that have the ability to deleverage at a time of stagnating/falling profits. In our central scenario (65% probability) we expect US IG spreads to widen from 109 bps (on December 6) to 140 bps by end-2020. Spreads for euro IG should widen less (moving from 101 bps to 110 bps), as European Central Bank (ECB) easing will likely supress volatility.

Underweight US high yield credit. Due to our expectation that the US economy will soften next year, we foresee a rise in the US HY default rate. Defaults have been increasing in the US energy sector already, driving credit spreads for CCC and lower-rated companies sharply up. So far, there has been little contagion to the rest of the HY space, but this is unlikely to last in our view, leading us to expect US HY spreads to widen from the current 400 bps to 550 bps by end-2020 in our central scenario (65% probability).

Neutral euro high yield credit. We expect euro HY to outperform its US counterpart thanks to higher average quality, a lower rate of default (thanks to low exposure to shale oil-related energy companies) and indirect technical support from negative government bond yields and the ECB’s corporate sector purchase programme (CSPP). We foresee a limited rise in euro credit spreads, from 343 bps to 400 bps by end-2020 in our central scenario (65% probability). In our alternative, positive scenario of a cyclical recovery (25% probability), we see spreads remaining close to their current level, while in our negative, recessionary scenario (10% probability) we see them reaching 700 bps. Expected total returns could be flat (in euros), as the coupon may barely compensate for spread widening and the rise in German sovereign yields that we foresee.

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