Is the global battle to rein in inflation finally under control? Not quite, says Insight Investment’s April LaRusse, who has closely watched recent market data flows as central banks such as the European Central Bank (ECB) work to combat inflationary pressures.

Nevertheless, despite some widespread analyst predictions of recession² last year, LaRusse says a surprisingly healthy picture is emerging among key European credit market indicators. In particular, she notes a recent rise in the growth of European order books with companies across a range of sectors reporting a broad increase in new orders.  
 

“Given various predictions last year analysts are scratching their heads as the latest figures come through. While there is growing divergence across some economies such as the US and China, we are generally seeing much better data than was originally expected,” she says.

“Real progress has been made by the central banks in tackling inflation. And while the European labour market still looks somewhat overheated - with low unemployment and rising wages - interest rate rise expectations are coming down relative to the US. The near-term economic figures all seem to be showing the same thing: that things are getting better for the European economy and fixed income markets.”

Wage pressures

Despite these signs of improvement, LaRusse cautions that some post pandemic weakness is now evident across the European service sector. She also expects the ECB will continue to face tough wage pressures throughout 2024. At a regional level LaRusse notes a growing divergence between Northern and Southern Europe, with recent purchasing managers’ index (PMI) data³ suggesting a strengthening in the latter and a weakening in Northern Europe. 

Stubborn inflationary pressures persisted throughout last year, leading some analysts to predict a series of interest rate cuts would be made throughout 2024. As inflation has fallen, however, LaRusse believes lower market expectations on interest rate cuts are now more realistic.

“Before Christmas some market analysts were pricing in 150 basis points of rate cuts in 2024. That kind of shift only ever really happens if you face quite a deep recession. Thankfully, markets are lowering their interest rate cut forecasts and predictions of a one per cent cut in rates this year do not seem unreasonable,” she adds.

While European fixed income markets appear to be stabilising, investor uncertainty is never far away. This year sees US and various European elections which could trigger heightened uncertainty and increased market volatility. However, LaRusse remains unfazed by this and believes credit markets have previously shown they are resilient enough to weather most electoral surprises.

“While global investors don’t particularly like the uncertainty elections bring, risk markets such as credit and equities have tended to perform well at the time of elections and have continued to deliver some positive returns,” she says.

Market optimism

Weighing up the immediate prospects for European credit markets LaRusse says both fundamentals and margins appear strong, with investors seeing a generally low level of credit defaults in the market.

“From a credit standpoint, momentum in European investment grade (IG) has remained positive and we believe Europe looks relatively cheap compared to US credit right now. From a sectoral perspective we see value in European financials but also in utilities, a sector which has seen substantial recent issuance and can offer some defensive properties.

“As geopolitics shifts, and with limited new European investment grade bonds to buy we also expect to see more spending on European defence - funded largely through debt, while European government bond net issuance is also likely to remain elevated,” she concludes.

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