The Euro Area Corporate Health Monitor (CHM) moved further into ‘improving health’ territory in the fourth quarter.
Our Corporate Health Monitors (CHM) for the U.S. and Euro Area are a composite of six key financial ratios for the entire non-financial corporate sector that rating agencies use when rating companies. The data required to construct the CHMs are unfortunately published with a long lag, but the Monitors have nonetheless been useful over the years in heralding trend changes in corporate spreads.
As noted in earlier Insights, the fact that the U.S. CHM is in ‘deteriorating health’ territory confirms that the U.S. credit cycle is in the late stages, although we still believe that it is too early to give up the carry in the U.S. corporate sector because real interest rates and bank lending standards have not deteriorated. Historically, signals from the CHMs have been most useful when confirmed by these other two factors. Meanwhile, the Euro Area CHM moved further into ‘improving health’ territory. Corporate fundamentals are generally moving in a positive direction for the corporate bond space in Europe, despite some early signs of froth in the high-yield sector.
That said, corporates are not trading on fundamentals at the moment; it is a QE, liquidity-driven market. The ECB will continue to shrink the stock of government bonds available to the private sector for at least the remainder of this year, forcing investors into riskier asset classes.
There is a risk that the hunt-for-yield that has driven investors beyond their “quality” comfort zone goes into reverse. If the long-end of the Bund curve were to shift up another 50-100 basis points, investors that have stretched for yield may be able to move up-in-quality and still meet their yield bogies. This shift would place upward pressure on spreads, especially in the high-yield sector.
Nonetheless, Bund yields are more likely to decline than rise. The Greece negotiations could provide some spread turbulence, but the improving economy and the aggressive ECB backstop extend the sweet spot for Eurozone corporate bonds.
Related:
Is Greece Still a Country if Someone Else Owns Its Assets?
