The European economy started the year with solid foundations, despite the Omicron variant that spread across the continent in late 2021 and early 2022. Robust growth is still being driven by strong consumer spending, with the jobless rate approaching a level indicating full employment. In the US, the poorest consumers have also become wealthier since 2015. As a result, on both sides of the Atlantic, households have seen their finances become stronger, allowing them to cope with the current increase in goods and services prices.
For companies, profit margins are firm, particularly in Europe, with EBITDA margins rising since 2020 and now averaging over 20%. In the investment-grade credit market, it is estimated that higher inflation will adversely affect only 10% of companies. The companies set to suffer from inflation are in the consumer goods, retail and chemicals sectors. Core inflation is also likely to ease back again if energy prices decline, after rising in recent weeks as a result of nerves concerning the geopolitical situation.
Ukraine: a European crisis, not a global one
This means that the Fed’s monetary tightening is taking place against a more robust macroeconomic backdrop than in previous cycles of rate hikes. The US central bank could carry out 10 rate hikes in 2022 and 2023 (seven in 2022 and three in 2023), and the markets have already priced this in to a large extent. In Europe, there is less of a consensus about future developments. Investors appear to be anticipating seven rate hikes in 2022 and 2023, but economic momentum is more dependent on energy prices in Europe than in the US.
The war in Ukraine is mainly affecting European countries via commodity imports, which make up 68% of Russian exports. Estimates show that the conflict is likely to reduce global growth by 0.8 percentage points, similar to the impact of the Omicron wave. However, the situation varies between the major economic blocs: growth could slow by 2.1 points in the eurozone, as opposed to only 0.1 points in the US.
Positive momentum, barring tougher sanctions on European gas supplies
The war in Ukraine has caused swap spreads to rise to stress levels similar to those seen at the time of the eurozone crisis and close to those of 2008. This is an interesting valuation indicator, because it shows that a lot of bad news is already priced in. As a result, the positive macroeconomic situation and companies’ solid finances could make it justifiable for investors to return to the bond markets, focusing their allocations on high-beta issuers. The rise in yields – 7% in USD for a global high-yield strategy based on CDS indices – could provide some cushioning against adverse developments in Europe. In addition, the US high-yield market features a large number of energy companies, and should benefit from rising hydrocarbon prices.
Finally, investors should also maintain defensive exposure in terms of duration. Our team adopted this position in January in response to the change in the Fed’s tone, and it has not been undermined by Russia starting its offensive in Ukraine on 24 February. Overall, we believe that there has been a shift in momentum and that the time is right to increase bond positions again, particularly in the high-yield segment. The crisis is also likely to cause the US yield curve to continue flattening.
Philippe Gräub
Olivier Debat