US and European credit-market performance diverged significantly in July. Indeed, the European high-yield market underperformed its US counterpart to the highest degree since the European sovereign-debt crisis in 2011 (see figure 1).
Figure 1. US high-yield credit outperforms
Source: ICE Bond Indices, as at August 2020.
This is largely because US high-yield credit delivered its best month since 2011, despite the fact the country reported its weakest GDP growth since the 1940s. It is clear that the market is paying more attention to strong technicals and expectations than backwards-looking economic data.
The reach for yield in this age of unprecedented policy stimulus is more apparent in the US than in Europe. US interest rates have converged with those in Europe and Japan, prompting yields on US investment-grade credit to fall to all-time lows (about 30bps below pre-coronavirus levels). By contrast, European investment-grade yields are about 30bps wider. Investment-grade credit has also outperformed high yield, as investors move away from treasuries and other assets that offer record-low yields.
Earnings season and the summer lull mean that stronger demand in the US has been met with slower supply, resulting in a substantial technical tailwind. At a time when earnings are under significant pressure, this may be a signal that is would be beneficial for the European Central Bank to launch a US-style support programme for fallen angels.