European Fixed-Income Outlook: Stay High Quality in 2023

European bond-market performance was among the worst on record in 2022, as Europe ran the gamut of geopolitical, economic and market storms. While problems persist and we expect further periods of volatility, we believe the worst impact on markets is past and that investors will find opportunities in 2023—particularly in investment-grade and select high-yield credit.

With a lot of bad news already priced into credit markets, yields look compelling to us at current levels. Starting yields have historically been reliable indicators of future credit returns over a three- to five-year horizon. On that basis, yields1 of 4.3% for euro-denominated investment-grade credit and 7.8% for high yield offer attractive risk-adjusted potential returns.

Outlook for European Corporates Brighter than Feared

European economies are entering a tough period in 2023. But we don’t think Europe faces an environment as bad as during the global financial crisis. Developments in recent months have been better than expected. An aggressive effort to rebuild natural gas stockpiles and a warm start to the winter season have limited the risk of energy rationing, reducing the probability of a severe economic downturn.

Accordingly, we anticipate a shallow recession with rates plateauing towards the end of the year. While that scenario may be somewhat challenging for equity investors, we think that debt issued by high quality companies should do well.

Euro-denominated credit has entered the current tough period in good fundamental shape, making it resilient to future storms. Corporate margins and leverage have recovered from the COVID emergency period and returned to long-term average levels, and earnings and cash flows should remain adequate to protect bondholder payouts.