Corporate Credit Outlook 2025: All about yield (still)

December 19, 2024

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Our investment teams set out the key themes credit investors should look out for in 2025.

Credit spreads are undisputably tight, reflecting the strength of much of the corporate universe, but we believe yields remain attractive. We expect healthy fundamentals and technicals should provide investors with a favourable environment for corporate credit over the next 12 months.

Our base case is for greater dispersion in growth and financial performance across developed markets but believe all credit sub-asset classes will deliver positive total returns in 2025.

1. Yield curves set to steepen further but long yields to stay rangebound

Yield curves steepened in 2024, a process we expect to continue as policy rates have yet to reach their terminal level in the US, UK or Euro area. Furthermore, fiscal concerns in developed markets could cause an increase in term premia.

Tariffs under the new US administration may lead to further dispersion across regions and greater divergence in monetary policy.

Given weak Eurozone growth, we believe the European Central Bank will cut rates towards 2% before the summer. The Federal Reserve, meanwhile, is likely to continue to ease policy, but more gradually, with our expectation for a Fed funds rate of around 3.75% by June. The Fed’s approach seems prudent given the potential impact of trade and immigration policies on employment and inflation.

We do not expect similar moves lower in long yields, with fiscal consolidation seemingly not a priority in many developed countries.

However, we believe the changing shape of credit yield curves no longer justifies concentrating investments in the very short end.

Figure 1: Steepening in IG credit curves

Source: Macrobond, ICE Index Platform and Bloomberg data as of December 5, 2024. ICE BofA Euro Corporate Index (ER00). ICE BofA US Corporate Index (C0A0). Indices chosen represent best proxy for the broader European and US investment grade markets. Yields are EUR-hedged. USD figures are hedged using the Bloomberg USDEUR 12 Month Hedging Cost Index (FXHCUE12). For illustrative purposes only.

Overall, the outlook for the US is more positive than other developed markets. As such, US credit may be used as an anchor allocation in global portfolios, while EUR and emerging markets are likely to see more volatility and require more active risk management.

2. Fundamentals: Positive ratings migration to slow but defaults to stay low

Fundamentals were a tailwind for credit in 2024. Ratings migration was positive in all major regions, with significant upgrades from high yield to investment grade.¹

Defaults seem to have peaked in US HY, and we expect to see the same happen for leveraged loans in 2025, where issuers have seen an improvement in cashflows from rate cuts.

Fundamentals also look robust for US investment grade. Tax cuts will be welcomed by corporates, coming on top of decent earnings growth.

The combination of weak domestic demand and higher US tariffs may increase risk in European credit, particularly among high-yield issuers. Nevertheless, we do not think this will cause a spike in defaults.

Emerging-market corporates have also seen positive ratings migration, a trend we expect to persist. The default rate peaked in 2024 and could decline further in 2025,² absent a major external shock. 

3. Technicals to remain tailwinds

Investors bought yields in 2024. Inflows into credit were consistently strong despite tight spreads.

In addition, after two years of rising yields and equities, private and public defined-benefit pension schemes in the US and Europe saw an improvement to their funding ratios.^3,4

As these schemes get closer to maturity, de-risking will continue. In the US, this could stimulate further inflows into aggregate-type bond strategies. In Europe, we expect higher inflows into government bonds and investment-grade credit, which should offer competitive returns against equities.

Staying in Europe, the appeal of money market funds and short-term deposits should finally start to recede in 2025 as interest rates fall. We think a healthy share of reallocations will go into credit markets.

CLO surge

The rise in policy rates in 2022-2023 boosted demand for floating-rate instruments, including collateralised loan obligations (CLOs). Concerns over persistent inflation may continue to foster demand for floating-rate securities.

In European leveraged loans, M&A activity has disappointed since 2022, when base rates began to increase.⁵ We expect activity to recover in 2025, but perhaps not until H2, meaning refinancing will continue to be the dominant driver of new issuance.

Trump 2.0 and US credit

In US HY, supply is expected to increase, but this will be likely be matched by inflows, with investors attracted by average yields of around 7%.⁶ At a broad level, we believe US HY will be a beneficiary of US economic policy given the high proportion of domestically focused businesses.

In leveraged loans, the market is likely to see continued appetite for floating-rate assets and muted net supply. Inflows to loans have barely skipped a beat since the Fed began its rate-cutting cycle in September. We see no reason why this will not continue.

In emerging markets, we expect the supply and demand dynamics that have defined the past three years to persist, with the technical impact of a smaller investible universe⁷ more than offsetting outflows.

4. Searching for value

In most credit asset classes, spreads enter 2025 close to historical tights due to a combination of low default risk, limited spread volatility, high equity valuations and improving recovery rates.⁸ Something would need to break to materially change valuations.

Figure 2: Credit spreads at historic lows

Source: ICE Index Platform, as of 2nd December 2024. Global Corporate index (G0BC), Global High Yield Constrained Index (HW0C). Indices selected represent best available proxy to markets discussed. For illustrative purposes only.

In contrast with early 2024, the convexity argument is no longer as powerful, with an average market price of around 100 for BB-B rated European HY and 98.5-99 for its US counterpart,⁹ unless investors are willing to go deep into lower-quality credits. The same is true for leveraged loans.

However, the search for carry will likely continue. We still see value in high-yielding assets, while maintaining our up-in-quality bias. The macro backdrop does not justify chasing weak issuers.

Figure 3: All about yield

Source: Macrobond, ICE Index Platform, as of 11th December 2024. ICE BofA US High Yield Index (H0A0), ICE BofA European High Yield Constrained Index (HEC0). Indices selected represent best proxies for broader European and US high yield markets. For illustrative purposes only.

We believe 2025 will see more regional dispersion, sector differentiation and the re-emergence of hedging costs as factors in asset allocation decisions. Below are the key themes our investment desks believe investors should watch out for in 2025:

1. US anchor: We believe US credit may be used to anchor global portfolios, with well-identified macro and sector narratives, while EUR and emerging markets could experience greater volatility.
2. UK yield play: The spread premium between EUR and GBP-denominated corporate bonds has increased due to the underperformance of UK rates.¹⁰ Adding GBP credit exposure could enhance the yield of pan-European portfolios.
3. EM corporates: EM corporates showed resilience in 2024 (outside of China) despite high US rates.¹¹ Nevertheless, US tariffs will be a key theme in 2025, and global appetite for EM is unlikely to change until there is clarity on this issue.
4. The spread factor: The long end of the credit curve in US IG saw spreads tighten to historical tights in 2024.¹² The same can be said for the long end of the European IG curve. Here, low BBB-rated corporate bonds with short-to-medium term maturities offer the most attractive valuations, in our view.
5. European IG: European autos underperformed other non-financial corporates in the second half of 2024. Despite structural challenges, current valuations could offer a re-entry point. European utilities also offer a spread premium over broad non-financial corporates, while banks offer a positive spread above non-financials, particularly in senior debt, supporting our overweight. We remain cautious on real estate given the prospect of further ECB rate cuts and economic uncertainty.
6. US HY differentiation: The economic agenda in 2025 favours sector differentiation in US high yield. We see value in utilities and energy, parts of healthcare and telecoms, which are unlikely to be exposed to trade wars, while US auto manufacturers have healthier credit metrics than their European peers. In a reversal of 2024, in our opinion Yankee bonds look less attractive, while expectations for looser regulations favour domestic US banks. Additionally, we will moderate our exposure to sectors that appear more vulnerable to macro risks, such as retail and hospitality.
7. European HY: In EUR high yield, we began cutting exposure to cyclical sectors in mid-2024 and see no reason to change that view. We believe non-financial subordinated bonds are unlikely to deliver the same relative performance in 2025. Real estate offers pockets of value, but the sector has already seen spread compression. It is too early to increase exposure to retail, but this sector could offer opportunities if consumer spending and real income recover.
8. The hedge factor: With US and Euro monetary policies likely to diverge further, the cost of hedging for EUR-based investors will increase. This should lead carry driven investors in the region to favour EUR-denominated assets.

In summary

In our view, 2025, credit markets should be well-supported by resilient fundamentals and favourable technicals. Investors will continue to be drawn to higher yields and take a balanced approach to duration.

Potential headwinds, such as trade policies, labour market dynamics and fiscal challenges, could mean higher spread volatility. We expect investors to be selective in their allocations, with an emphasis on higher-quality issuers and income.

References

1.S&P Global, ‘Global Credit Outlook 2025,’ December 4, 2024
2.Moody’s, ‘2025 outlook stable for emerging markets,’ November 19, 2024
3.Milliman, ‘Pension Funding Index,’ December 9, 2024
4.Willis Towers Watson, ‘World’s largest pension funds return to growth,’ September 9, 2024
5.White & Case, ‘Refinancing rally lifts loan issuance as interest rates recede,’ December 2, 2024
6.ICE BofA Platform, as of December 11, 2024
7.JP Morgan, ‘EM Corporate Outlook and Strategy 2025,’ November 26, 2024
8.S&P Global, ‘Default risk eases for most US market sectors in Q3 2024,’ October 18, 2024
9.ICE BofA Platform, as of December 11, 2024
10.ICE BofA Platform, as of December 13, 2024
11.International Monetary Fund, ‘Emerging Markets Show Resilience Despite Global Monetary Tightening,’ July 12, 2024
12.ICE BofA Platform, as of December 13, 2024

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of December 2024 and may change without notice.

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Index descriptions

G0BC – The ICE BofA  Global Corporate Index tracks the performance of investment grade corporate debt publicly issued in the major domestic and eurobond markets. Qualifying securities must have an investment grade rating (based on average of Moody’s, S&P and Fitch), have at least one year remaining term to final maturity as of the rebalancing date, at least 18 months to maturity at point of issuance and a fixed coupon schedule.

H0A0 – The ICE BofA  US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

HW0C – The ICE BofA  Global High Yield Constrained Index contains all securities in The ICE BofA  Global High Yield Index (HW00) but caps issuer exposure at 2%.

HE0C - ICE BofA Euro High Yield Fund Directive Constrained Index contains all securities in The ICE BofA Euro High Yield Index but caps issuer exposure at 10% and the total weight of all issuers over 5% of the Index to no more than a total of 40%. Qualifying bonds are capitalization-weighted; provided: a) the total allocation to an individual issuer (defined by Bloomberg tickers) may not exceed 10%; and b) the total allocation to large cap issuers (those having a weight that is greater than 5% of the Index) may not exceed 40%. The face value of bonds of issuers that exceed the above requirements are reduced on a pro-rata basis so as to bring them to the 10% and 40% limits, respectively. Similarly, the face value of bonds of all other issuers that fall below the 10%/40% caps are increased on a pro-rata basis. In the event there are fewer than 20 issuers in the Index, each is equally weighted and the face value of their respective bonds are increased/decreased on a pro-rata basis.

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