Retracement in global stocks dampens sentiment on European junk bonds

Investor sentiment towards European junk bonds, a key market risk barometer, has softened as global stock market volatility and tensions increase on Russia’s borders- Ukraine drives investors away from risky assets.

The spread on the iTraxx Crossover index, which measures the cost of hedging against junk-rated companies that default on their debt, rose as high as 295 basis points on Friday, a level not reached since from November 2020. The spread has increased by about 50 bps since the end of 2021.

Cost to Hedge Default Line chart across a basket of high-yield bonds* shows investor interest in European junk bonds rising from recent lows

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

However, for many investors, the risk of a land war in Eastern Europe meaningful against the threat of runaway inflation.

US Federal Reserve Chairman Jay Powell on Wednesday stopped short of ruling out a rate hike at each of the seven central bank meetings still taking place this year. The market is currently pricing in nearly five rate hikes this year, with only one expected in 2022 as most recently in November.

“It wouldn’t be a big shock to see [the iTraxx] wider drift, especially in the past few days, on the back of the [US Federal Reserve’s] Fraser Lundie, chief credit officer at Hermes Investment Management, said.

Lundie said high-yield assets tend to track other riskier assets like stocks, as well as greater volatility. The Vix Index, sometimes referred to as Wall Street’s ‘fear gauge’, this week hit its highest level in more than a year.

However, given the sharp sell-off in tech stocks in January, Lundie said he was surprised that iTraxx didn’t move higher.

“I think that’s partly because the underlying foundation for high productivity is really strong,” he said. “Default rates are at a floor, balance sheet health is good and earnings are strong.”

“When stocks move a lot, it tends to have some contagion effect on non-investment credit,” said Gilles Dauphine, head of alpha euro fixed income at Amundi. The differences between Russia and Ukraine “didn’t help” investor sentiment, he added.

In the US, junk bonds have sold off this week. Yields on a widely watched high-yield bond index run by Ice Data Services rose to 5.11% on Thursday, the highest level since November 2020, as money-policy expectations eased. Tighter currencies have pushed riskier debt prices lower.

Strong economic growth, low default rates and an open funding market have helped support the market, averting further 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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