Talking Heads – There is more to come from investment-grade credit

This is an audio transcript of the Talking Heads podcast episode: There is more to come from investment-grade credit

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insight and analysis on the topics that really matter to investors. In this episode, we’ll be discussing eurozone investment-grade credit. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Victoria Whitehead, Head of Investment-Grade Credit. Welcome, Victoria, and thanks for joining me.

Victoria Whitehead: Thank you, Daniel, for giving me this opportunity to talk to you today.

DM: If we look at eurozone investment-grade credit in particular, it has been a good year. Arguably we have a recession in the eurozone, but nonetheless credit has held up. What are your views on why that’s happened and whether, from an investment point of view, it’s still a good time potentially to be looking at credit?

VW: It has been a good end of year for investment-grade credit, driven by total returns, which are strong. We have seen credit spreads tighten. We think there is still an opportunity to have strong total returns next year.

The European investment-grade market still has value in terms of spreads. We see credit spreads as historically relatively cheap versus their average over the past 10 years. We may see another 30 basis points of potential tightening next year and as we expect the ECB to start cutting interest rates, that would have a positive impact on total returns.

This is still a good entry point . In our view, we should see returns of at least 6% or 6.5% next year based on there being a possible 50 basis points of interest rate cuts.

DM: As well as credit spreads potentially tightening further, what are some of the other dynamics that could be important for eurozone credit?

VW: The prospect of higher returns next year will drive inflows into the asset class, so we anticipate investors continuing to buy investment-grade credit in 2024.

One of the other major drivers will be the prospect of lower corporate issuance. Companies have been active over the last few years, issuing a lot of corporate bonds. But with much less merger and acquisition activity over the last few years in Europe, corporates probably do not need to keep issuing the same amounts. That gives the potential for less supply next year, which, combined with higher demand from investors, should push credit spreads tighter.

DM: While all this sounds positive, we have to consider the risks as well. Are you concerned about the fundamentals for [European] corporates in the coming months?

VW: It is clear we will likely see growth stagnating in Europe over the coming quarters due to the headwinds from higher interest rates which have yet to be fully felt in the economy. There is also a structural slowdown in German manufacturing, which is of particular concern right now.

However, it is important to underline that European investment-grade companies are [mainly] strong blue-chip corporates that have made a lot of effort over recent years to strengthen their balance sheets. So they are entering a likely period of weaker growth with strong balance sheets and high cash balances, which should enable them to navigate the choppier waters over the coming quarters.

It’s also worth noting that we have seen a lot of corporate credit rating upgrades over the last 12 months. So again, these large capitalisation, blue-chip European corporates are entering this period in a solid condition and we expect them to be able to weather the weaker outlook.

DM: Victoria, thank you very much for joining me.

VW: Thank you very much.

DM: This is our last podcast of 2023. We wish everyone Happy Holidays and look forward to you joining us again in 2024.