Euro High Yield May Be Most at Risk From a Fed Hike: Analysis

Unlike U.S. credit markets, which have recently moved to reflect probability of the U.S. Federal Reserve raising rates at its December meeting, the European high-yield credit remains anchored by dovish European Central Bank policy expectations. This discrepancy may now put European high yield debt at risk of a selloff should the Fed deliver a rate rise next month and if the ECB falls short of investors' dovish expectations, Bloomberg strategist Simon Ballard writes.

Recent price and spread moves in the European credit market have shown little allowance for changing Fed interest rate increase risk. The Euro quality curve is still firmly underpinned by expectations that the ECB will retain, if not increase its degree of monetary accommodation at the Dec. 3 Governing Council meeting. Market expectations are for at least an extension of the ECB's quantitative easing program or a deposit rate cut.

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Bloomberg euro high yield index minus Bloomberg euro investment grade index

The spread between the Euro investment grade index and the Euro high yield index is currently close to 330 basis points compared with above 400 basis points at the beginning of October.

If the Federal Reserve does embark on an interest rate normalization path in December and should the ECB fail to deliver the anticipated further easing, the Euro quality curve could steepen as European high yield credit loses its monetary stimulus and underperforms the broader market.

On the other hand, U.S. credit markets are largely priced for a Fed interest rate increase, with the spread between the Bloomberg U.S. investment grade and high yield indexes having recently widened back towards the 500 basis point mark, just shy of the three-year high (520 basis points) seen back in September.

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Bloomberg U.S. high yield index minus Bloomberg U.S. investment grade index

Note: Simon Ballard is a credit strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.

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