
After a turbulent summer, the credit markets have made an impressive recovery, shifting to a more risk-on mode. This trend is evident in the behavior of investment grade (IG) spreads, which have remained below 100 basis points for the twelfth consecutive month. The stability of these levels demonstrates strong investor confidence in the U.S. economy, also reflected in the gap between USD and EUR spreads, with the former significantly lower.
Globally, swap spreads continue to tighten as government bonds weaken relative to swap rates. With quantitative tightening in full swing and an abundance of collateral, excess liquidity is being steadily drained. However, while many corporations reduced leverage before the global financial crisis, most developed economies continue to run significant budget deficits, pushing the public debt-to-GDP ratio to new highs.
Investment strategies and positioning
In the current environment, there is a slight overweight on spread risk, particularly in SSA and covered bonds, while exposure to corporate credit remains neutral. In the next quarter, focus will be on adding shorter-duration credit if spreads remain range-bound, taking advantage of a more attractive carry environment while awaiting better valuations.
European debt and the French case
The European peripheral markets show a positive outlook. Southern economies, such as Spain, Portugal, and Greece, are experiencing stronger GDP growth than their northern counterparts, with an improving debt-to-GDP ratio and continued ECB monetary easing. A tourism boom has further accelerated their recovery, positioning them as post-Covid success stories.
Conversely, France is emerging as the weak link in Europe. Government bond spreads reflect this divergence, with Spanish and Portuguese yields now significantly lower than French yields across the curve. Even Greek yields, up to seven-year maturities, are now below those of France. This scenario could lead to rating upgrades for Spain, Portugal, and Greece in the coming year, while France faces the risk of a downgrade below AA-, potentially triggering forced selling and further pressure on French bond spreads.
Emerging market debt: opportunities and risks
Recent debt restructurings, such as Sri Lanka’s macro-linked bonds, highlight the importance of fundamental analysis in emerging market debt. However, with high-yield sovereign issuers still offering double-digit returns and markets maintaining confidence in continued Fed easing, demand is expected to remain robust, leading to further spread tightening.
In the investment grade space, the current lack of sovereign issuance, combined with a significant private sector dollar accumulation, suggests that spreads should tighten further.
What’s your perspective on these market trends? Share your thoughts in the comment section below!