While uncertainties remain, we retain our positive outlook, supported by resilient growth in the US, steady investor demand and a supportive monetary easing cycle in Europe. As for the fundamentals, the peak in investment-grade (IG) credit quality for this cycle is now behind us. Nonetheless, both US and European IG bond issuers are still generally in good shape: They now have bigger reserves of cash, lower net debt and better net margins.
Plenty of positive factors in the US
US investment-grade (IG) corporate debt continues to benefit from a resilient economy and the initial loosening of monetary policy by the Federal Reserve in recent months. We expect the economy to remain well orientated in the first quarter of 2025.
Recent trends in consumption have uncovered weak spots, especially in lower-income credit card repayments and car loans. Any impact on corporate balance sheets of a slowdown in consumer spending is, however, likely to be mitigated by improved cost management. Rising levels of household debt are partly offset by higher real wages and increased wealth.
We expect the new administration’s business-friendly approach and deregulation to provide tailwinds for corporates.
Despite all these positive factors, it is likely that bond yields will have to fall significantly for there to be a meaningful shift from money-market funds into investment-grade debt.
US investment-grade credit spreads are tight, leaving the segment vulnerable to any negative change in sentiment. As such, we are selective, seeking to benefit from carry with the expectation that credit spreads will remain range-bound in the first quarter.
Strong demand for new issues
In the primary market, we continue to anticipate strong demand for longer-dated yields. In our view, 2025 will see healthy inflows as yields have reached attractive levels for investors seeking to lock in carry.
We see prospects as particularly favourable for financials (banks and non-office real estate investment trusts (REITs)) on account of their strong fundamentals and attractive valuations.
The exceptional strength of the US economy relative to other developed markets has to be weighed against the risks of escalating trade tensions. With that in mind, we favour, where possible, issuers mostly exposed to the US economy.
Spread tightening in Europe
In Europe, uncertainty and concerns over the risks of a trade war loom large. A recovery in consumption has been dampened by the structural slowdown in Germany. We expect disinflation to continue, with core inflation to fall below the ECB’s 2% target in 2026. This should pave the way for further rate cuts, with the depo rate falling to below neutral in 2025.
We expect European investment-grade credit to remain well oriented due to healthy fundamentals and investor demand for yield as money market rates fall. Although spreads are tight, we see scope for further tightening in the first half of 2025.
We particularly favour the banking sector, which has benefited from higher interest rates at a time of strong asset quality with capital and liquidity ratios historically high. Costs at European banks have been significantly reduced after widespread restructuring. The sector benefits from strong diversification in terms of geography and business, which should provide resilience against macroeconomic shocks.
We expect default rates to remain at 3%-4% in 2025.
For us, as active managers, security selection is critical in this challenging macro and geopolitical environment.
