The Best Foil for Political Risk May Be Mundane Macro Data: Analysis

As volatility surges amid a scandal engulfing the Trump administration across the Atlantic, investors are putting their faith in signs of a healthier euro-zone economy to underpin appetite for risk.

The sharp rise in volatility measures this week has resulted in a broad-based risk off tone, suggesting credit could remain prone to near-term widening. Analysis shows a strong level of historic correlation between market volatility and corporate bond spread performance.

Paradoxically, recent European economic data may bolster the case for continued risk appetite. The European Union’s statistics office Tuesday confirmed growth of 0.5 percent in the three months through March, a sign of health that could underscore continued credit-spread compression.

Just as investment advisers offer the caveat that ‘past performance is no guarantee of future returns,’ it may now be that past correlation is no guarantee of the same relationship holding true in the future. If historic correlation does hold, European corporate bond spreads would seem set for a degree of consolidation and widening bias as the political uncertainty persists and speculation over a possible impeachment of President Trump continues.

If economic growth metrics prove to be the more important driver of risk asset performance though, currently compressed credit spreads could see further incremental tightening from here as they shrug off the negative implications of elevated volatility levels.

(Simon Ballard is a credit strategist who writes for Bloomberg. The observations made are his own and are not intended as investment advice.)