Advertising Material for professional investors only*
European credit has been under pressure from the fear of stagflation, credit exposures to Russia and an illiquidity premium. However, the market has had time to price in the credit risk and to sell what had to be sold (ex-Russia). Furthermore, the shape of the stagflation risk as well as the ECB response are by now well understood. We view European credit (e.g. High Yield, Banks…) as currently offering a point of entry that typically does not last very long. Furthermore, we expect the market to be more focused on stable returns offered by fixed income in the coming months.
1. Fear of stagflation
The fear of stagflation linked to much higher energy prices is still rocking the markets though we remain far from oil levels comparable to previous oil shocks (e.g. 1970s) if we take into account that we are far richer today. Brent peaked close to 130 dollars and is now around 110. One might wonder if buying credit is the best option to sell the risk of a stagflation scenario: War is costly and Russia desperately needs the dollar revenue of oil and energy; it won’t massively curtail output unless it is completely cornered. This is something the Europeans will strive to avoid, Europe having no incentive to leave Russia without a way out. Other members of OPEC might consider increasing output to cool down this price inflation. Then CDS such as the itraxx cross-over and the embedded put options in High Yield map the region of fear very well with a likely better risk/reward than equities. Finally, the ECB’s reaction function is now well understood. The APP programs ends in Q3 and a hike is likely after. This means that in a few days, peripheral bond markets should have priced in the new more hawkish ECB.
2. Credit exposures to Russia
Foreign banks have at least 120bn dollars in exposures to Europe based on BIS banking statistics, with a French and Italian bank often cited. Some investors have portfolio exposures to Russian bonds, and some corporates have direct investment exposures such as in the automobile industry. Much of this is known, though surprises are possible when some interlinkages are opaque.
3. Liquidity premium waiting to be absorbed
In a crisis, the most illiquid asset class typically comes under pressure first and moves the most. This is a function of a specific premium attached to it, namely the need for liquidity as the market moves to cash and short duration positions. This premium is a function of risks being shifted by one group to another that is in short supply (limited number of risk takers) as Keynes, a macro investor, once postulated. Risk has hence both a supply and demand and a concept of liquidity that are interlinked. We had seen some signs of caution on European High Yield ahead of January and since then it has strongly underperformed (see Graph of the Itraxx cross-over below).
Source: Nordea Investment Funds S.A. and Bloomberg
Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches and subsidiaries. This document is advertising material and is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest Key Investor Information Document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management AB recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. A summary of investor rights is available in English through the following link: https://www.nordea.lu/documents/engagement-policy/EP_eng_INT.pdf/. The Legal Entities’ branches and subsidiaries are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and subsidiaries. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and/or subsidiaries.