Favorable European economic data and rising confidence are fanning the hope that the worst of the eurozone recession has passed and the economic region may be on the mend. Second-quarter eurozone gross domestic product grew 0.3%, the first positive reading since the third quarter of 2011.
Growth was led by Germany and France, whose economies grew 0.7% and 0.5%, respectively. However, while GDP expanded in the northern countries, beleaguered southern countries like Italy and Spain continued to report economic contraction (negative 0.2% and negative 0.1%, respectively), albeit at slower rates of contraction. Although the beleaguered Southern European nations remain stalled in recessions, German industrial production, factory orders, and exports are on the rise and should continue to provide a lift to the rest of the eurozone. In addition, upbeat data out of China, such as stronger-than-expected trade data, also spurred hope that emerging markets would continue to support global economic growth.
Positive macroeconomic economic news and a renewed confidence spurred European investors to drive corporate credit spreads tighter as macroeconomic fundamentals have been the main driver of corporate bond performance in Europe.
However, while European credit spreads have tightened, corporate credit markets in the United States have not participated in the move, and spreads have widened slightly for the year. We think there are two main reasons that U.S. credit spreads have not fully shared Europe's appetite for risk: 1) U.S. interest rates have generally been on an uptrend since the beginning of May and, 2) idiosyncratic risks are rising from increased shareholder activism and aggressive share-buyback programs.
Second-quarter GDP in Italy and Spain contracted at their slowest quarterly rates (0.2% and 0.1%, respectively) since the third quarter of 2011, prompting economists to believe that the economic deterioration in both countries may be close to an end. Since the beginning of July, the yield on Italy's 10-year bond has dropped 34 basis points to 4.18%, which is only 42 basis points higher than where yields bottomed out at the beginning of May. This move lower has come despite the fact that S&P lowered its rating on Italy to BBB from BBB+ in July.
As the yield has dropped, the additional credit spread that investors required to purchase Italian sovereign bonds as compared to German bonds has tightened to +230 basis points. This is the least amount of additional compensation that investors have been willing to accept for Italian risk since the middle of 2011.
Likewise, since the beginning of July, the yield on Spanish 10-year bonds has declined 36 basis points to 4.36%. The additional credit spread that investors required to purchase Spanish sovereign bonds as compared to German bonds has tightened to +248 basis points. This is the least amount of additional compensation that investors have been willing to accept for Spanish risk since the middle of 2011.
