Aegon AM: Resilience holding firm as markets test the outlook for European ABS
The rebound in risk assets, supported by easing geopolitical tensions and improving inflation dynamics, has helped stabilise sentiment. But the picture beneath the surface remains uneven. Growth is diverging across regions, inflation continues to prove more persistent in some areas than others, and central banks remain cautious in their approach.
Against this environment, investors are looking more closely for areas of the market that can offer consistency. European asset-backed securities (ABS) is one such area as it continues to demonstrate a level of resilience that has proven relatively strong compared to other areas of credit markets. The combination of relatively stable performance overall and sustained issuance highlights the depth of demand supporting the asset class, even in the current uncertain environment.
A market supported by strong technicals
From a technical standpoint, European ABS continues to benefit from a supportive backdrop. Demand remains firm and continues to absorb supply, helping to stabilise spreads even as broader market conditions fluctuate.
At the same time, relative value remains a key consideration. Compared to corporate credit, ABS still offers attractive spreads for the level of risk, particularly when viewed alongside its shorter duration profile and lower sensitivity to interest rate volatility.
Also, with limited scope for further compression, carry is likely to play a more important role in returns rather than capital appreciation. In this context, the ability of the asset class to deliver relatively stable and predictable income becomes even more important.
Balancing opportunity with the uncertain outlook
Looking ahead, the outlook remains closely tied to macro developments, particularly around inflation and geopolitical risk. The trajectory of oil prices, and the broader US – Iran situation, remains a key variable. Any reversal in recent trends could quickly reintroduce volatility across both rates and credit markets.
Central bank policy will also continue to shape the landscape. While the Federal Reserve appears to be in a holding position for now, the European Central Bank remains focused on inflation, creating a more challenging environment for growth.
For most risk assets, this combination presents a difficult balance. For European ABS, the impact is more mixed. While the asset class is not insulated from these pressures, its structural characteristics mean it tends to respond differently - and often more gradually - than other areas of credit.
Fundamentals: gradual pressure rather than abrupt stress
From a fundamental perspective, a more challenging macro backdrop is likely to translate into some deterioration in credit performance over time. Higher living costs, softer real income growth and weaker economic activity will inevitably place pressure on both households and corporates.
However, for European ABS, this is expected to manifest as a gradual increase in arrears and defaults rather than any sudden deterioration. This is particularly true across prime RMBS, auto ABS and granular consumer ABS exposures, where underlying borrower profiles remain relatively strong.
Labour markets continue to provide an important anchor. Despite broader economic uncertainty, employment levels remain supportive, helping to underpin borrowers’ ability to service debt. In addition, consumers retain several financial buffers, including elevated savings levels and, in many cases, increased housing equity built up over recent years, particularly while employment remains supportive.
Structural protections also play a critical role. Credit enhancement, deleveraging and excess spread provide important layers of defence, helping to absorb losses and mitigate downside risk. Historically, these protections have enabled European ABS to navigate periods of macro stress with relatively limited negative returns.
Positioning: carry, structure and relative stability
As we look ahead, the balance of risks appears somewhat skewed to the downside, particularly given limited scope for further spread tightening. In such an environment, credit risk premia typically rise, and investors become more discerning in their allocations.
However, European ABS continues to stand out in relative terms. Compared to traditional corporate credit, it benefits from shorter duration, lower loss expectations and inherent and structural protections rather than reliance on favourable refinancing conditions.
Importantly, performance dynamics have historically been different. Periods of spread widening have often been followed by relatively quick recoveries, supported by carry and pull to par dynamics rather than prolonged capital loss.
With spreads still offering a premium over similarly rated asset classes and a strong structural foundation in place, European ABS remains well positioned. The combination of resilient fundamentals, supportive technicals and attractive carry continues to underpin its appeal, particularly in a market where visibility remains limited and stability is increasingly valued.