Politics poses biggest risk to European credit

Potential crisis around trade, Brexit and Italy’s government could cause trouble for credit markets.

Political issues, rather than underlying business performance, pose the biggest threat to European credit markets, according to an analysis by S&P Global.

In its European Corporate Credit Mid-Year Outlook report, S&P Global said market metrics appeared relatively benign, with 12-month trailing default rates of around 2 percent and it forecast this was unlikely to rise beyond 3 percent over the next year.

It added: “The benefits of a strong pickup in global economic growth are feeding through into cash flows, and financing conditions are set to remain supportive given still-modest inflationary pressures and central banks’ desire to take a very gradualist approach to policy normalisation.”

Credit and loan markets appear to be more conservative with credit and loan growth rates being relatively constrained and far from the peak seen before the financial crisis of 2008.

“The credit cycle is not at a point of excess: bond issuance and loan growth annual rates are relatively modest, corporate cash remains plentiful, profit margins improving and debt levels are high but easing as EBITDA improves,” the report said.

One business area that did stand out as a concern was mergers and acquisition activity. Current buoyant M&A activity could pose some risks of overvaluation and overpayment in the next few years, S&P Global said, but noted that much of this activity is being driven by operational challenges to businesses in the current environment and that savings from synergies could not always be assured. It points out that 24 percent of European M&A in the past six months has been in the troubled consumer sector.

However, Europe has some serious political issues to face which could be disruptive for business and have unpredictable consequences for credit markets.

Negotiations on the UK’s departure from the European Union is one of the biggest risks currently looming over the continent and S&P Global said the risk of a disruptive outcome, such as the UK crashing out of the EU without a deal, have risen in recent months.

There is also concern about Italy’s new government, which has become confrontational with the EU over both fiscal policy and immigration.

Lastly Europe also faces the risk of becoming embroiled in a trade war with the US. S&P Global notes that “political risk – especially in relation to trade and tariffs – has been greater and more troubling than expected at the start of the year, but this has not yet translated into a broader repricing of risk assets.”