Volatility Could Spell Opportunity for Active Investors
For active bond managers—particularly those with multi-sector, multi-regional strategies—volatility may create new relative-value opportunities.
For instance, the surprise result of the French elections widened the spread of OATs over Bunds to a level that was unlikely to be sustained, presenting an opportunity for investors to trim their Bund holdings in favor of OATs. It also highlighted a value opportunity in Spanish government bonds, which in our view have much better fundamentals, were trading attractively versus OATs and have outperformed since the election.
Going forward, we still see value in corporate bonds of multinational companies that sold off post-election, where we think the impact of French politics has been overdiscounted. Likewise, we think French bank bonds likely represent an opportunity too.
We also continue to favor European investment-grade credit bonds, which were caught up in the post-election sell-off. They offer attractive yields in a higher-for-longer rate environment, and we expect their default risk to remain very low. They may also enjoy capital gains, as the ECB resumes rate cuts later this year. By contrast, we think the weakest CCC-rated credits remain vulnerable.
For UK investors, the new government’s commitment to following the fiscal compact suggests that the longest-term gilts could be undervalued. We believe that the risk premium embedded in the long end of the UK yield curve (highlighted by its relative steepness versus other markets) will likely decline, favoring the 30-year segment over the 10-year segment.
Risks Look Contained—for Now
Given the absence of Frexit risk, the recent French parliamentary elections seem much less risky for corporate credit than were the presidential elections of 2017, as this time very few sectors faced immediate threats.
In the year ahead, political stability is likely to remain fragile in France. We think French sovereign bond spreads are unlikely to return to their pre-election levels—but other euro sovereign bonds should recover. ECB rate cuts will support European bonds generally, and we expect euro sovereign bonds that trade with a yield spread to Germany to remain attractive to investors.
From a credit perspective, we believe the election result neutralizes several European credit risks, and we expect spreads to grind tighter given strong summer technical factors and benign underlying fundamentals. European credit is still attracting inflows, yields remain mostly unchanged year to date and supply is drying up given the earnings-season blackout. We expect to see more value opportunities arise as political developments trigger intermittent sell-offs, and we think investors will likely find attractive yield opportunities in the months ahead.
