As for most global risk assets, 2022 was a terrible year for euro investment grade bonds. These circumstances occur because the market faced a near perfect storm of negative conditions. In particular, inflation returned with a vengeance, causing central banks to raise interest rates sharply from historically low levels of aggression. An even more unexpected factor was the fact that in 2022 the war returned to Europe. The conflict in turn aggravated inflationary problems and continued great concerns about energy security and recession risks.
“The improvement in valuations and the downward trend in inflation are good news for bonds with investment in euros,” according to Álvaro Antón, head of abrdn for Spain and Portugal. Easing inflationary pressures support the outlook for European investment grade credit, reduce pressure on the European Central Bank (ECB) to continue to raise interest rates powerfully.
“The low interest rate and yield environment of the last few years, with which fixed income investors have suffered, has given way to a completely new landscape. In 2020, if you invested in Treasuries, the likelihood of negative returns was very high – in short, it was paying to buy government bonds – while even in the highest-yielding sectors, total returns were under threat.” says Paul Skinner, chief investment officer at Wellington Management.
“The downward trend in inflation should stabilize in the coming months, thanks to the large reduction in energy prices, less supply chain problems and increasingly favorable base effects,” he comments to the regarding anton about the current scheme.
The improved inflation outlook also translates into less pressure on bond yields. While some further ECB hikes are due in 2023, these appear to be highly integrated with current market expectations, with little risk of being exceeded. “Therefore, the downward margin that would be derived from further significant increases in bond yields seems limited,” says Antón.
In 2022, the unprecedented rise in gas prices in Europe was a dominant issue in the euro fixed income markets. The enormous impact it had on consumers and businesses stoked real fears of recession.
Now, the risk of a recession for Europe has largely diminished due to improved gas supply diversification in Europe, as well as an increase in gas storage. Consequently, the risk for euro corporate bonds has also been reduced considerably.
The significant improvement in China’s growth prospects following its recent “reopening” is another positive turning point for euro corporate bonds. The European business sector is relatively exposed to China through trade and tourism channels. “Chinese growth after the Covid crisis is likely to be driven by domestic consumption… If it materializes, this consumption could generate strong demand for European imports,” analyzes the abrdn expert.
Thus, the improvement in inflation prospects, the lower risk of recession and the recovery of growth in China are positive aspects for investment grade corporate bonds in euros. “It is important to remember that corporate bonds in euros have a solid track record of outperforming government bonds in periods when economic growth accelerates and inflation remains subdued,” says Antón.
In addition, it highlights that “corporate bonds also benefit from the improvement in the prospects for corporate growth and profitability, as well as from the following accommodative fiscal and monetary policies by central banks and governments”.
All in all, while 2022 was a difficult year for euro investment grade bonds, the outlook for 2023 is more favorable thanks to reduced inflationary pressure, receding fears of recession and the recovery of growth in China.
These factors, combined with attractive valuations and higher total returns than government bonds, make euro corporate bonds an attractive option for investors looking to diversify their portfolios and earn attractive returns.
“THIS NEW SITUATION GENERATES UNIQUE OPPORTUNITIES FOR Investors IN Long-Term Fixed Income, Especially Credit Monitoring, As Long And When They Manage To Deviate Successfully, Skinner Assures Regarding The Opportunities That Habrary Can Follow In. bond market.