Rising rate volatility is driving a growing divergence between US and European credit markets, says Sarah Harrison, Senior Portfolio Manager at Allspring Global Investments, as investors assess which regions are most exposed to escalating geopolitical risks. Speaking to Trader TV, Harrison discusses the corporates most vulnerable to the ongoing energy crisis, examines the scale of AI-related capital expenditure and its potential impact on productivity, and shares her views on where the most significant underlying risks lie within private credit markets.
Interview
Josephine Gallagher – So, starting off with some context, as rate volatility is back. How are you seeing this impact on US versus European credit markets?
Sarah Harrison – Yeah, so one of our key calls going into 2026 was that there would be greater volatility in the government bond space and the credit space, and the credit would act as a sort of ballast for this year. And that is certainly playing out. I would love to say that we predicted the conflict, but we absolutely did not. We knew there was a risk of geopolitical risk, but certainly did not predict what is going on at the moment. But that rate volatility has come to the fore. And so as a result, in our multi-sector portfolios, we have been taking advantage of moves in the global government bond space, particularly in Europe. And so in our view, the number of rate hikes that were being priced in at the height of the conflict, you know, got to between three and four. That was too, too big a number. And so we have taken a bit of exposure there, in the European government bond space. In the credit space, it’s actually the inverse. Our view is that if the conflict is protracted, European credits will be hit a lot harder than US credits, and we weren’t being compensated for that in spread, and still aren’t really being compensated for that in spread. European credit has underperformed US credit, so in the high yield space, European high yield has underperformed US. High yield by about 60 basis points at the wides, but even at that point, it was only about 10-20 basis points wide to US high yield, and Europe is a higher quality market to begin. So in our view, you just weren’t being paid appropriately to be in European credit, which is why we reduced the allocation to European credit and moved more into US credit across investment grade and high yield.
Josephine Gallagher – What corporates and sectors are being hit hardest by this energy crisis that we’re seeing right now, and where do you expect to see the biggest spread waving and tightening?
Sarah Harrison – So in our credit exposure, we are not typically big buyers of airlines. They tend to the way they trade, the way they price. They don’t necessarily compensate you well enough for the tail risks that are out there. But what little airline exposure we did have. We have sold down near the beginning of the conflict. One of the benefits of the way our team works is that I sit right across from the transportation analyst, and, you know, we’ve been having ongoing conversations about what is happening, particularly in Europe, with jet fuel shortages, and we’re starting to see a knock-on impact. We’re starting to see flight cancellations. We’re starting to see, you know, quite, quite significant issues there. And so we have reduced airlines’ exposure on the belief that it will continue to underperform. An area that we are concerned about that is actually separate to what is going on in the conflict in Iran is at the UK building materials space. We’ve gotten a lot of negative headlines out of the UK building materials companies. And the reason for that is quite simple, 2021 was the trough when it came to, you know, locking in your mortgage rate. If you locked in for five years, that mortgage is rolling off this year. So there will be many, many homeowners who are having their mortgage payment either triple or having to dig into their savings to spend a lot of capital to keep that mortgage payment the same or lower than it would be otherwise. That doesn’t leave a lot of money for renovations or home improvements. You know, you’re not going to replace your roof unless you really need to. And so we’re quite negative on the UK building material space as well.
Josephine Gallagher – Now throwing AI into the mix of all this volatility, where do you see AI adoption making the biggest impact to credit markets over the medium term?
Sarah Harrison – So there are a bunch of different ways that AI will impact the credit markets. The first is at a macro level, obviously, AI will have an impact on productivity. We have yet to see what those numbers will look like, but in our view, that is the big question mark, and that is something that we could debate for hours on end and not come to a conclusion. So I won’t spend much time on that. The second piece is how AI will impact credit or corporate balance sheets. In any rational credit market, the spread should widen on the announcement and then tighten on the result. You are going to have to spend CapEx if you’re a corporation and have to implement AI into your processes, and so we are looking for compensation for that CapEx spend that should happen in the beginning. We don’t think that corporates should be pricing the results from day one, and that’s something we’re paying attention to when we do our underwriting. And then finally, all this hyperscaler issuance is obviously going to have a very big impact on the credit markets. You know, the latest number is like 100 billion of issuance this year, mainly in the US, but we’re starting to see that issuance in Europe as well. And so that is going to have an impact on the index. That’s going to have an impact on how investors think about this space. So those are the three kinds of key things that we are looking at
Josephine Gallagher – Now it’s also very difficult to talk about credit markets without talking about private credit and the ongoing issues in that space. How far-reaching are the problems in private credit, and do you see that contagion effect take place in the public markets and more broadly?
Sarah Harrison – Surely, interestingly, I was having a conversation with a journalist the other day, and they mentioned to me that their articles on private credit get double the clicks versus any other article that they write. And so it is a bit of a self-fulfilling prophecy. It’s just it’s what people want to read about, and so it’s what journalists write about. Our view is that there is no wholesale good or wholesale bad here, that there will be a distribution of success among managers based around underwriting skill and around sourcing. We don’t see this as systemic risk. Actually, in our view, one of the big issues that investors should be thinking about is the semi-liquid fund structures. And so in a high yield fund, you are thinking about liquidity. It is one of the less liquid fixed income asset classes, but it is still liquid. So in the height of the pandemic, you had a nine-point dislocation in the European high-yield ETF (exchange traded fund). It’s quite large, but there was still a bid for that European high-yield ETF. We manage that cash balance through ETF to having cash through yields call paper, through quasi investment grade double B’s. So there’s always that buffer of stuff that will likely, in a, you know, in a difficult market, be saleable. What will be interesting to see is how the private credit managers who have these semi-liquid fund structures deal with redemptions going forward. We’ve just seen the first wave, and obviously many of them have capped the amount of redemptions as a high-yield manager, high Yield is one of the less liquid fixed income asset classes, and so when you run a daily dealing fund, it’s something you’re thinking about on a regular basis. And so, for example, we’ll obviously, we’ll have cash in the fund. We’ll have yield to call. We’ll have high-quality quasi-double B’s. We’ll have some ETF. All of these are ways that we think about managing liquidity. But there was always a price for these things. Even in the height of the pandemic, there was a nine-point dislocation in the European high-yield ETF that is still tradable. So yes, it’s a nine-point dislocation, but there’s still a bid for that. And so it will be interesting to see how these semi-liquid structures evolve and how redemptions are dealt with over the next several quarters.
Josephine Gallagher – And finally, what else should investors and traders be mindful of this week? What else did we miss out in this conversation?
Sarah Harrison – Yes, so in our view, and this is something that we’ve talked about in the past, Jo. Our view is that there is no playbook for this presidency, and we’re only in April, and you’ve seen the issues in Venezuela, the conflict in Iran. We don’t know what the rest of the year could bring. We think that there will be a brief reprieve in June, July, um, where we will see more attention being paid to the confirmation of the new Fed chair, and what the evolution of monetary policy looks like. But, you know, we can’t rule out the potential for additional geopolitical risks down the line, and it is something that we are paying quite a lot of attention to. The other thing to be mindful of is that if the ECB does end up pursuing several hikes through the course of 2026 it does have the potential to negatively impact levered credit. And so as a result, we are quite cautious lower down the credit spectrum. We are cautious on low single B and triple C’s. We’ve had a good cleanup of the high yield market. Just given the cycle change, many corporates that have been kind of dragged along by low interest rates have defaulted, and so they have left our market where we’re left with a much cleaner market. And that being said, there are still a handful of corporates that may suffer quite, quite a lot from higher interest rates. And so security selection, as always, is extremely important to make sure that you are avoiding those credits whose capital structures do not work in a world where interest rates may go 50, 75m 100, basis points higher.
