Global funds are giving way to European junk

Investor sentiment towards European junk bonds, a key barometer of market risk, has eased as global stock volatility and growing tensions on the Russia-Ukraine border have forced investors to give up risky assets.

The spread of the iTraxx Crossover index, which measures hedging costs against companies with unwanted ratings that have not paid their debts, rose to 295 basis points on Friday, a level not reached since November 2020. The spread has increased by about 50 basis points from the end of 2021

A line chart of hedging costs against defaulting on a basket of high-yield bonds *, showing investors' concerns about European junk bonds, has been rising since recent lows

The move comes after US officials warned that there was a “reporting opportunity” for Russia to invade Ukraine within weeks. About 100,000 Russian troops are currently stationed near the border.

For many investors, however, the risk of a land war in Eastern Europe is fading in the face of the threat posed by high inflation.

The chairman of the US Federal Reserve, Jay Powell, on Wednesday stopped ruling out the increase in interest rates at each of the seven central bank meetings to be held this year. Markets are now pricing nearly five interest rate hikes this year, when only one was expected in 2022 until November.

“It shouldn’t be a big shock to see [the iTraxx] more widely, especially in the last few days, on the back of [US Federal Reserve’s] hawk slope, ”said Fraser Lundi, head of credit at Hermes Investment Management.

High-yield assets typically track other risky assets such as stocks, as well as wider volatility, Lundi said. The Vix Index, sometimes called the “measure of fear” on Wall Street, reached its highest point in more than a year this week.

However, given the sharp sell-off of technology stocks in January, Lundi said he was surprised iTraxx did not rise.

“I think it’s partly because the fundamental background for high returns is really strong,” he said. “The default percentages are at a level, the balance sheet is good and the profits are strong.”

“When stocks move a lot, this tends to have some effect on the non-investment grade loan,” said Gilles Dauphin, head of alpha euro fixed income at Amundi, who also expects a bigger jump on iTraxx. The confrontation between Russia and Ukraine “does not help” the mood of investors, he added.

In the United States, junk bonds sold out this week. Yields on the widely observed high-yield bond index, managed by Ice Data Services, rose to 5.11% on Thursday, their highest level since November 2020, as expectations of tighter monetary policy pushed the price of risky debt lower.

Strong economic growth, low defaults and wide open funding markets have helped support the market by preventing more intense pressure. “There is some confidence that the Fed will be able to break the needle,” said Nicole Hammond, portfolio manager at Angel Oak Capital Advisors.

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