OREANDA-NEWS. Fitch Ratings says in a new report that European high yield (EHY) issuance should increase despite the slowest start to the year since 2008. Capital market volatility has widened the gap between assessments of benign short-to-medium-term fundamental credit risk and more uncertain long-term concerns over secondary market liquidity, global growth and economic policy management.

Fitch says default rates will remain below 1% by market value in EHY, based on its majority 'BB'-rated issuer concentration in outstanding volumes, coupled with their long-term maturity profiles and low debt service burdens. Most borrowers can afford the option of riding out the volatility and wait for spread premiums to tighten.

The EHY market is in better shape than US high-yield as the latter has a growing list of stressed commodity-related issuers and a higher share of lower-grade maturities to refinance, while also having endured a considerable surge towards wider spreads since 2010.

Consecutive years of record issuance in EHY since the financial crisis, underpinned by capital-constrained banks, monetary stimulus and corresponding, pro-cyclical "search for yield", combined to bring about a robust, mature and diversified market by region, sector and investor base.

In 2015, EHY materially outperformed USHY by 5.5pp in total return. However, the "de-coupling" of the EHY market from the USHY market in asset quality and policy bias has not been reflected in the capital markets funding environment. Since the start of 2016, market volatility has led to an increase in cross-asset correlations - as oil, stocks and bonds increasingly moved in sync - and, as a result, sensitivity of EHY to volatility in total returns in its US counterpart is on the rise in fund flows and spread-widening, casting doubt on the theme of divergence in 2016.

Total returns in EHY are negative in the year to date, although they continue to outperform USHY. Despite recent stabilisation and recovery in correlated risk assets, Fitch continues to expect rising energy and mining-related defaults in the US, which will likely continue to support higher premiums for volatility across both markets well into the summer, as longstanding concerns over liquidity and recoveries become more pronounced.

However, current spreads imply default rates far above historical levels, which are unlikely to materialise in performing sectors. Investors will increasingly see opportunities to deploy ample cash balances to boost returns against expectations for a period of sustained low global interest rates.

Moreover, the weak global growth outlook and the impact of weak commodity demand recently resulted in the downgrades of formerly investment-grade issuers into EHY indices. Volumes in the market therefore continue to expand despite weak new issuance, while the mix of credit quality continues to improve.

The report, European High-Yield Insight - March 2015, is available at www.fitchratings.com.