Fall in global equities undermines sentiment on European junk bonds

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Investor sentiment towards European junk bonds, a key barometer of market risk, has faded as global equity volatility and rising tensions on the Russian-Ukrainian border prompt investors to abandon risky assets.

The spread on the iTraxx Crossover Index, which measures the cost of hedging against junk-rated companies defaulting on their debt, reached 295 basis points on Friday, a level not seen since November 2020. The spread widened by around 50 basis points since the end of 2021.

The moves come as US officials warn there is a “strong possibility” that Russia could within weeks invade Ukraine. Around 100,000 Russian troops are currently stationed near the border.

For many investors, however, the risk of a ground war breaking out in Eastern Europe has nothing to do with the threat posed by runaway inflation.

U.S. Federal Reserve Chairman Jay Powell on Wednesday did not rule out raising interest rates at each of the central bank’s seven upcoming meetings this year. Markets are now forecasting nearly five interest rate hikes this year, compared to only one expected in 2022 as recently as November.

“It shouldn’t be a major shock to see [the iTraxx] widens, especially in recent days, on the back of the [US Federal Reserve’s] hawkish tilt,” said Fraser Lundie, head of credit at Hermes Investment Management.

High-yield assets tend to track other risky assets like stocks, as well as broader volatility, Lundie said. The Vix index, sometimes called Wall Street’s “fear gauge,” hit its highest level in more than a year this week.

Still, given the sharp selloff in tech stocks in January, Lundie said he was surprised that the iTraxx hadn’t risen higher.

“I think that’s partly because the fundamental backdrop for high yield is really strong,” he said. “Default rates are at rock bottom, balance sheet health is good and earnings have been strong.”

“When stocks move a lot, it tends to have a contagion effect on non-investment grade credit,” said Gilles Dauphine, head of alpha euro fixed income at Amundi, who also expected a higher spike. important to iTraxx. The standoff between Russia and Ukraine is “not helping” investor sentiment, he added.

In the United States, junk bonds sold off this week. The yield of a widely watched high-yield bond index managed by Ice Data Services hit 5.11% on Thursday, its highest level since November 2020, as expectations of monetary policy tightening dragged the price down risky debt.

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

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