Euro credit: Steadying the course?

This article is an extract from our Q3 2025 Active Fixed Income outlook.

The past: what just happened? 

Between March and May, European markets were shaped by global trade tensions and a notable shift in domestic fiscal and monetary policy. The most significant development was Germany’s historic reform of its constitutional debt brake in March, enabling substantial new infrastructure and defence spending.

This triggered a sharp repricing in rates, with 10-year bund yields surging 34bps – the largest daily move since reunification – before reversing in April as global risk sentiment deteriorated.1 The European Central Bank responded to weak growth and falling inflation by cutting rates twice, 25bps in both March and April, contributing to a broader bond market rally. In May, bond yields stabilised as global trade tensions eased, though concerns about US fiscal policy kept upward pressure on global yields.

European credit markets initially widened – investment grade spreads rose by around 17bps through March and April – but recovered in May as the US and China agreed to de-escalate tariffs and a UK-US trade deal signalled improving bilateral momentum.2 President Trump’s threat of a 50% EU tariff reintroduced some volatility, though a July deadline gave markets breathing room. Meanwhile, the UK, while politically turbulent with the Reform Party gaining ground, followed the ECB’s lead with a May rate cut and reached a new agreement with the EU to deepen economic ties. Despite ongoing external risks, the region ended the period in a more constructive position, underpinned by easing policy and a pivot toward fiscal support.

The present: Politics over economics

Credit markets are holding up well even if there are signs of unease. In our latest Euro credit scorecard discussions, the dominant concern remains the macro backdrop: ongoing trade tensions, a fragmented global political picture, and the spectre of tariffs. But there’s also a recognition that recent positive headlines have delayed the arrival of harder data, whether in the form of slowing US growth, rising inflation, or broader market stress. Demand remains robust, particularly in the 3–3.5% yield space, bolstered by the continued absence of defaults or significant negative momentum. Germany shows early signs of recovery however growth remains elusive due to trade war uncertainty. The complexity of EU trade negotiations makes a near-term deal with the US unlikely. Meanwhile, valuation signals are mixed: BBBs are clearly compressed versus their A and AA peers, prompting a shift in our focus.

We’re leaning toward more tariff and recession-resistant, carry-enhancing opportunities — specifically shorter-dated BBs that are less exposed to cyclical risk, and select T1 structures where the risk/reward ratio still looks attractive. Demand remains strongest in the 3 to 7-year segment, where the curve offers enough yield without excessive duration risk. Sector-wise, we’re rotating away from autos – a sector that has already rallied strongly and is now one of the tightest year-to-day – and toward banks, which still offer solid fundamentals and meaningful carry. We’re also paying closer attention to politics over pure economics, for instance, how US healthcare policy could affect pharma, or the potential for a withholding tax on U.S. assets — a risk that may still be underappreciated.

Overall, we maintain a neutral short-term stance – markets are showing strength, seasonal factors are supportive (especially as supply dries up in late June), and the ‘buy-the-dip’ mindset remains in play.

Outlook

Looking ahead, Europe enters the second half of the year with a stronger fiscal backdrop and renewed political momentum to support growth through increased public investment in defence and infrastructure. Credit market valuations have largely recovered from the volatility that follow ‘Liberation Day’, reflecting improved sentiment and de-escalation in some key trade disputes.

However, risks remain. Tariff policy uncertainty—particularly around pending US-EU negotiations—continues to cast a shadow, while broader geopolitical instability could still disrupt fragile market confidence. The balance between policy-driven support and external volatility will be key in shaping the credit and rates landscape in the months ahead.

Longer term, our outlook remains cautious: macro risks are still unresolved, and valuations leave little margin for error.

What could go wrong?

One of the most pressing concerns is whether we will begin to see meaningful weakness in global growth, particularly in the US and Europe. So far, markets have weathered the storm, but the delayed effects of tariffs, tighter financial conditions and waning fiscal stimulus could begin to materialise in the data. If growth falters significantly, recession fears could quickly become central to the market narrative.

Another critical factor is the trajectory of inflation. For now, inflation remains relatively contained, which has allowed central banks to maintain a dovish stance. However, any unexpected spike – whether from supply shocks, wage pressures, or geopolitical tensions – could challenge the current policy path. A shift away from the rate-cutting bias would likely have meaningful implications for both duration-sensitive assets and risk sentiment.

The question of fiscal sustainability is also of concern. Persistently high budget deficits, especially in the US, combined with rising debt-to-GDP ratios, could eventually test the market’s tolerance. If investors begin to lose confidence in fiscal discipline, we could see pressure build in sovereign spreads, funding costs, and even broader risk asset pricing.

Lastly, geopolitical risk remains a constant source of potential volatility. The wars in Ukraine and the Middle East continue to evolve, and any significant escalation – whether military or economic – could unsettle markets. These conflicts also carry the risk of second-order effects, such as energy market disruption, refugee flows, or realignment of global alliances, all of which could impact investor confidence and capital flows.

This article is an extract from our Q3 2025 Active Fixed Income outlook.