OREANDA-NEWS. Fitch Ratings says in a new report that European high yield (EHY) exhibits characteristics of entering a late stage in the credit cycle. Despite asset quality and a policy environment that compares favourably to the US high-yield market - where sectors affected by the commodity price declines and rate rise expectations portend an increase in defaults and marked-to-market losses - the EHY market has for some time concealed long-standing risk factors. Monetary easing and the consequent "search-for-yield" anchored low default rates, attracted fund in-flows and contributed to pro-cyclical refinancing activity as coupons declined and terms eased in favour of issuers.

Last week's shock announcement from Spanish renewables and infrastructure group Abengoa SA ('CC') highlighted longstanding investor concerns over structural complexity, weak European corporate governance and the potential fallout from slowing global growth and emerging market volatility. Compounding the uncertainty over Abengoa, and its broader impact on the EHY market, are untested jurisdictional frameworks and cross-border enforcement mechanisms.

In its latest quarterly European High-Yield Insight report, Fitch says that premia on eurozone peripheral credits may rise following losses from Abengoa, while risks are growing for credits in sectors exposed to currency, commodity price and emerging market volatility.

Investors will increasingly emphasise credit selection to avoid losses. However, benign asset credit quality, with more than 60% of total instrument volumes rated 'BB', and expected enhancements in policy rate support from the European Central Bank's (ECB) quantitative easing (QE) programme, support a low default rate outlook for EHY over the medium-term. Even if Abengoa were to default in the near-term, the trailing 12-month default rate is likely to remain below 1% in 2016 - well under the long-term average.

Relative asset quality and policy support notwithstanding, the continuation of weak economic growth and lack of pricing power limits corporate profit generation and may translate into outstanding credits relying on favourable capital market conditions well into the future. Ongoing volatility in 2016 will reflect the tension between investors' heightened sensitivity to potential market losses and faith in the ECB's QE programme to mitigate any risk of sustained outflows.

Market volatility is likely to be a headwind to issuance in 2016, with volumes expected to be 10%-20% lower, as the post-crisis 'bank-to-bond' issuance trend diminishes, and as issuers exhibit a reduced propensity to refinance callable bonds. M&A and issuance from foreign corporates will provide some support; however, the primary market will rely mostly on fallen angel 'BB' issuers refinancing maturing debt.

M&A-related issuance rose in 10M15, and the potential for 2016 is favourable as low growth prospects and low yields encourage companies to defend market share and boost returns through acquisitions.

EHY has demonstrated greater resilience to periods of risk aversion since 2012, notably during periods of net investor outflows, due to its increasing diversity by sector, region and risk profile, and market trust in policy support. However, divergent policy expectations, particularly between the US and the eurozone, introduce new concerns over global market volatility and its medium-term impact on the asset class.