Warning on European Credit Markets

BCA Research issued a warning about the outlook for European credit markets in a note on Tuesday, advising investors to adopt a negative stance on this asset class.

The analysts argue that European credit spreads have little room to narrow from current levels, leaving investors inadequately compensated for the increasing risk of a recession that could arise later this year or early 2025.

Key Concerns

One major concern highlighted by BCA Research is the impact of upcoming European Central Bank (ECB) rate cuts. Contrary to the usual market optimism associated with rate reductions, BCA warns that these cuts “should not be viewed as positive for credit” as they are likely to be accompanied by “darker days ahead for markets.”

Another critical issue is the maturity wall, which refers to the substantial refinancing needs of European companies in the near term. BCA predicts this scenario will raise borrowing costs, leading to a further deterioration of corporate balance sheets, especially for high-yield (HY) issuers.

This decline, combined with already strained balance sheets, increases the likelihood of more defaults in the upcoming months. BCA’s models suggest that European high-yield credit is currently expensive, further reinforcing their negative outlook.

Recommendations

As a result, BCA Research recommends that investors focus on higher-quality assets within their fixed-income portfolios, favoring sovereign bonds over corporate credit. They concluded, “The speculative default rate will rise over the next 12 months. Within fixed-income portfolios, we continue to recommend investors favor sovereign bonds over credit.”