Resilient Q2 growth underpins credit strength for the rest of the year

The last couple of weeks have been busy on the GDP front with a few countries reporting Q2 growth numbers. With the conflict in Iran starting in February, market participants worried that Q2 would be the first quarter in which we would see the full impact of oil and gas disruptions, with many predicting deep contractions as we entered Q2 and little prospect of a long-lasting peace agreement. The reality has been quite different and shows a much more resilient picture than many feared.

The main reason the bearish growth projections did not materialise was that oil prices peaked (for now) at levels that were significantly lower than some expected. There have been no other fuel or commodity shortages that would have meant parts of the economy just stop in their tracks. It goes without saying that this could change as the situation in Iran is showing no signs of resolution or even a complete ceasefire at this stage. However, it is worth noting that there are a few contingency plans that have eased the pain, at least temporarily, and that could continue to do so while we wait for transit through the strait to normalise. Saudi Aramco has moved part of its production through its East-West pipeline to the Red Sea, from where it could be transported to Asia. The UAE has made extensive use of its export terminals in Fujairah, which provide a route that bypasses Hormuz and leads directly into the Gulf of Oman. The US has released part of its emergency oil stock, China's demand for oil to add to its reserves has decreased as prices went up, and there was a large increase in exports by oil producers including the US. In addition to this, there is anecdotal evidence that vessels have in fact made it through the strait despite the blockade and missiles being fired since March, although it is very difficult to put a number to it as some of these vessels have turned off their navigation systems to cross the strait.

Europe and the UK were expected to be amongst the hardest hit in Q2 when it came to growth, given their reliance on imported oil and gas, along with parts of Asia for the same reason. The Eurozone showed growth of 0.4% QoQ in Q2, which translated into 1% YoY. Both numbers came in above expectations and represented an acceleration from Q1. There are divergences between countries, with Spain, at 2.7% YoY, at the top of the table among the larger economies and France, at 0.7% YoY, at the bottom, but overall, we are confident that the economy exhibited remarkable resilience. The UK's economy grew at a rate of 0.4% QoQ, resulting in 1.2% YoY, marginally above consensus. The US headline number was lower than expected but this was due mostly to inventories and net exports while domestic demand continued to grow at a decent pace. Perhaps the only disappointment was China, with Q2 growth at 4.3% YoY. The story there is less to do with the oil shock and more to do with the long aftermath of the government-induced property crash which continues to hit the investment component of GDP with no sign of relief. Exports and industrial production have picked up the baton which is not without consequences as other countries are not happy to see their domestic markets flooded with cheap goods as Chinese domestic demand remains depressed.

These numbers, along with the resilience shown in Q2, have prompted economists to revise their growth projections for 2026. These were understandably revised lower as the war broke out but are now moving back up as the graph below shows. The Bloomberg consensus is now for the US, UK and Germany to grow at 2.1%, 1.0% and 0.9% respectively. We would characterise these numbers as close to each economy's potential growth rate.

Credit analysts, as opposed to economists, have not moved their default rate estimates too much as a result of the oil shock. Corporate fundamentals continue to be healthy, as evidenced by a positive Q2 earnings season, and while there will be companies and sectors more affected (positively and negatively) than others, overall default rate expectations remain close to historical averages, according to Moody's. Although default rates are higher in the US than in Europe and are higher in loans than bonds, Moody’s expects all default rates to decline over the next 12 months. 

Given our preference for credit within fixed income, we are satisfied to see growth data holding up and being revised upwards towards potential growth rates in different geographies. While a position in higher quality credit does not necessarily need growth to be spectacular to perform well, it is positive to see resilience in the economy. In fact, it could be argued that resilient growth at levels close to potential growth is optimal for these sorts of investments from a risk-adjusted return point of view. Q2 growth numbers, therefore, strengthen our view that credit should continue to perform well, in the absence of an external shock or a significant heightening of geopolitical risks.