Investors pile in to European junk bonds as inflation cools

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European investors have been piling into the region’s risky corporate bonds to scoop up the chunky yields on offer, as they grow more confident in companies’ ability to refinance their debt.

A record $1.2bn has flowed in to European-listed exchange traded funds investing in the region’s high-yield bonds this year to Thursday, according to BlackRock data. That compares with flows in to European-listed ETFs investing in US high-yield bonds of just under $200mn.

This marks the first time that European ETF investors have favoured “junk” bonds in their home market over the US since 2019. Many believe that regional economies that are performing slightly better than feared means a more painful recession can be avoided, while falling inflation will allow central banks to cut interest rates, creating a supportive backdrop for junk issuers.

In contrast, the strength of the US economy and high levels of government spending relative to taxes could persuade the Federal Reserve to keep interest rates high for some time, say investors, which could hurt lower-quality companies.

“The European economy has been weak and diverging from the US over the past couple of quarters but, with the exception of German manufacturing, we think that’s starting to bottom and pick up,” said William Vaughan, associate portfolio manager at Brandywine Global. Bond yields have “come down enough from their peak that we see demand [from companies and households] for credit going forward”.

But Vaughan said that his worry for the US was that inflation could pick up again.

“You’ve got monetary policy on one side trying to slow the economy and you’ve got fiscal policy batting against it on the other, with the potential for tax cuts and employee retention credits totalling over $250bn before the election,” he said.

European investors have tended to opt for US…