Demand continues to run well ahead for US vs. European high yield. According to our proprietary fund flow monitor, US high yield retail funds have seen net inflows of over USD 40 billion this year, whereas European high yield flows are still negative, with over EUR 7 billion of outflows. Divergent supply pictures have also been a driver of relative performance. The primary market in both regions now looks to be almost shut down for the summer period, but it slowed gradually for Europe in July, vs. a steeper decline for the US, with July issuance tracking about half of June’s level. The stronger technical support for the US is evident in the fact that the main US high yield ETF (HYG) is trading at around its long-term average premium to NAV, whereas the European high yield ETF (IHYG) is trading flat to its NAV for the first time since May. (Data as of 4 August 2020).
What does this mean for fixed income investors?
The outperformance of US high yield is largely down to three factors. First, duration has performed better in the US. Second, the reduced cost of hedging US dollar assets to euros has made the market appealing for European investors. Third, US technicals have been more favourable. Absent a change in credit fundamentals, Europe could start to outperform, as US rates have already moved substantially and the supply picture in both primary markets is now similar given the August shutdown. The European market could also benefit from its higher quality status, as investors are increasingly recognising that markets have shrugged off the potential for worse data releases. In any event, both markets look set to grind tighter in the short term, given that technical conditions still seem to be supporting current valuations.
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