European junk bonds shine as risk spread hits two-year low

By Harry Robertson

LONDON, Jan 24 (Reuters) - The premium that investors demand to hold the riskiest European corporate debt has fallen to its lowest in just under two years, as buyers are lured by high yields and the prospect of central bank rate cuts.

The extra yield that investors demand for holding the debt of companies rated below investment grade compared to the risk-free rate fell to 373 basis points on Tuesday, its smallest since early February 2022, according to LSEG data on the ICE BofA euro corporate bond index.

So-called junk bond spreads tightened sharply in November and December as inflation fell and investors moved to price in deep interest-rate cuts from central banks in 2023, brightening the outlook for corporate borrowers and sending bond yields tumbling.

Spreads have continued to move lower, even as government bond yields have risen in the new year, as investors have rushed to lock in the high returns on offer.

"For the first time in many years high yield is living up to its name, offering very high levels of income at a time when defaults are expected to remain contained," said Paul Benson, head of efficient beta at Insight Investment.

The weighted average yield on the corporate debt in ICE BofA's euro high yield index is 6.5%, LSEG data shows, up from around 2.8% in 2021.

European lender ING said below-investment grade companies have issued around 2.5 billion euros ($2.72 billion) of debt so far in January, broadly in line with last year, and that it has been well absorbed by the market.

"There is some justification of current spreads based on expectations of rate cuts, lower inflation and strong demand," said Tom Ross, global head of high yield at Janus Henderson.

He said companies were refinancing, easing worries about how they might cope with higher central bank interest rates.

JPMorgan strategists said the recent rise in shipping costs from China to Europe, due to Houthi attacks in the Red Sea, were one risk that could hurt euro zone companies.

"We do see signs of complacency in the market," they wrote in a recent research note.

($1 = 0.9179 euros)

(Reporting by Harry Robertson; Editing by Amanda Cooper and Bernadette Baum)