(This story originally appeared on IFRe.com, a Thomson Reuters
By Christopher Whittall
LONDON, Dec 9 (IFR) - Spreads may be at record tights, but
credit practitioners across the industry reckon Europe still
offers the best prospect for reaping returns in 2014.
Markit's iTraxx Crossover index - the bellwether for
high-yield European credit - recently hit a six-year low of
312bp, while iTraxx Main, its investment-grade equivalent, has
also plumbed the depths at 77bp.
There is debate over how much further spreads can rally. But
many believe a dovish ECB combined with middling eurozone growth
predictions represent the best opportunities for credit
investors next year.
"Everyone is underweight Europe, especially US investors. We
see a low growth scenario compared with the US and UK, which
should make European credit a great place for money to hide,"
said Gennaro Pucci, founder and CIO at PVE Capital, a credit
The blossoming US economy - reinforced by solid non-farm
payroll data on Friday - has led some analysts to take bearish
views on the country's credit markets for 2014, as the US
Federal Reserve is expected to scale back its bond purchases,
causing rates to rise.
"There is a sweet spot in Europe that will continue for a
while, with no fear of a rates increase from the ECB. Looking at
the rate component, credit spreads are wider in Europe compared
with the US. And we are still a long way off the tights in Main
and Crossover we saw in late 2006," said Derrick Herndon,
portfolio manager at PVE Capital.
The spread between iTraxx Main and CDX has shrunk threefold
since April, but the European IG benchmark still remains 11bp
wider than its US counterpart, suggesting there is further value
to be extracted.
"There's increasing evidence the credit cycle is turning in
the US, which we don't see in Europe. Our prediction of European
returns of 1% for 2014 may not sound appealing, but it is versus
the US," said Stephen Dulake, European head of credit strategist
at JP Morgan.
The spectre of the Fed tapering hanging over the markets has
previously spooked investors. Ten-year US Treasury yields
rocketing to 3% in early September - almost double their May
levels - created ripple effects through financial markets. Main
and Crossover hit year-wides of 132bp and 529bp respectively in
The ECB's determination to anchor short-term interest rates
has provided some comfort to European investors, though.
Moreover, some believe there is no need to fear European
credit capitulating in the face of rising sovereign yields on
the other side of the Atlantic.
After all, Main's all-time tight of 20bp in June 2007
occurred in a very different interest rate environment.
Five-year Treasury yields were around 5%, while the German
five-year Bobl was at 4.4%.
"Credit returns have both a credit and a rates component.
What looks out of place right now is the rates component, which
is very low," said Peter Duenas-Brckovich, EMEA head of flow
credit trading at Nomura. "Credit spreads could tighten even if
rates rise, especially if the latter is due to strong economic
Hedge funds remain hopeful the ECB's Asset Quality Review
will encourage European banks to further mend balance sheets and
shed non-performing loans, offering investors juicy yields.
Arbitrage and carry opportunities in credit derivatives markets
also offer value for investors.
"While bond returns were low in 2013, there were a lot of
opportunities in the CDS space, and that will continue to be the
case in 2014. Credit spreads over-compensate for default risk.
We suggest generating P&L by stripping out that component,
whether it is through basis trades or carry trades," said Saul
Doctor, credit derivatives strategist at JP Morgan.
Selling credit options has proved to be a popular carry
trade through 2013, while other investors have turned to the
index tranche market to take more nuanced views to earn pick-up.
More generally, many see the facelift that European capital
markets are undergoing, where bank balance sheets are shrinking
and corporates are increasingly tapping investors directly, as a
long-term boon for credit.
"Banks continue to be disintermediated by the growing
European capital markets, which is a huge and positive
development. Historically, Europe has had underdeveloped capital
markets compared with the US and the fact that this is changing
is bullish for the structure of the markets," said
(Reporting by Christopher Whittall, Editing by Helen