Correlation between the corporate bond markets of the U.S. and Europe is usually a given. After all, both regions heavily influence each other's economies, with American companies being major players in Europe and vice versa. Despite the U.S. consistently outperforming its European counterparts economically, bond investors are typically more focused on whether economies are strong enough for companies to meet their debt obligations, rather than the magnitude of economic growth.
However, this previously dependable relationship has now broken down. Torsten Slok, the chief economist at Apollo Global Management, highlights the fact that spreads for CCC-rated securities have become increasingly tighter in the U.S. compared to Europe since the Federal Reserve began raising interest rates. This divergence in spreads is peculiar, considering that both regions are grappling with inflationary pressures, and the U.S. actually faces higher recession odds (60%) compared to the eurozone (50%).
Slok believes that this disparity may be due to a yield-level mirage present in the U.S. market. Investors seem to be placing more emphasis on the absolute levels of yields rather than the spread between these yields and the benchmark government debt.
"In essence," Slok explains, "we are observing an inconsistency in the pricing of lower-rated corporate credit in the U.S. and Europe. It is difficult to reconcile a situation where everything appears to be fine while we simultaneously face the potential of a recession."
He speculates that this inconsistency could be a result of a yield-level illusion prevalent in the U.S. lower-rated credit market. Investors may be more preoccupied with yield levels rather than considering the underlying fundamental credit risks associated with Federal Reserve rate hikes and the resulting permanent increase in capital costs.
This emerging discrepancy raises questions about the underlying factors at play in these markets and warrants further analysis to truly understand the implications for investors on both sides of the Atlantic.