Global high yield: Pivoting to Europe

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

The past: what just happened? 

Markets were initially shaken by fears over the economic consequences of President Trump’s tariff announcements. However, investors have increasingly interpreted the proposals as opening bids rather than firm policy, and recent legal challenges have cast doubt on the administration’s ability to implement the tariffs as initially presented.

Accordingly, risk sentiment has improved, with high yield spreads now slightly tighter than they were on the morning of ‘Liberation Day’. Yield-focused investors have shown a willingness to look through near-term volatility, stepping in as spreads widened and remaining engaged even as spreads have tightened. Yields peaked at 8.25% before retracing by approximately 100bps to 7.25%.[1]

The market has subsequently adopted the ‘Trump Always Chickens Out’ (TACO) narrative, as policymakers have walked back several initial aggressive stances – both in terms of proposed tariff levels and comments on the job security of the Federal Reserve Chair.

The present: TACO time? 

In March, ahead of the recent turbulence, we proactively reduced our macro credit score from +1 to 0. This reflected our view that the increased likelihood of volatility needed to be priced into spreads, and the probability-weighted case for tightening was no longer compelling. However, we maintained that the powerful ‘hunt for yield’ dynamic would remain a stabilising force in credit markets.

We are now raising our macro credit score back to +1. This reflects our view that credit risk is again attractively priced and that portfolios should carry credit risk above benchmark. We are comfortable running with wider spreads and higher yields, in line with our foundational belief that High Yield is primarily an income asset class where investors are usually well compensated for future credit risk.

We remain underweight the US in favour of Europe and emerging markets (EM): in Europe, we see more consistent policymaking and a stronger fiscal position to support upcoming infrastructure and military spending initiative, and we think EMs offer similar macro risks to the US but with higher spreads and yields.

We also maintain our underweight to the autos sector, which faces multiple structural challenges - from the transition to electric vehicles to shifting regional demand trends. Ongoing tariff uncertainty adds to this pressure.

Outlook

We expect spreads to grind tighter, supported by strong demand for yield. At current levels, we think yields remain historically attractive in the post-GFC environment. While tail risks remain, including renewed policy volatility or confidence shocks, these would need to reach a significant threshold to trigger a reassessment of default expectations.

We continue to prefer corporate risk in Europe and EM. European credit is more acclimatised to a slow-growth backdrop, and anticipated capital investment will likely support flows into the region over the medium to long term.

The broader leveraged credit ecosystem remains healthy, with public bonds, loans, and private/direct lending all contributing to balance sheet flexibility for issuers. The default outlook is subdued, and more importantly, credit loss expectations are improving. Issuers are increasingly avoiding hard defaults, opting instead for pre-emptive restructurings, or negotiated settlements. This trend is lifting recovery rates and enhancing investor outcomes.

What could go wrong? 

We see two key risks to watch:

• Escalation of policy disruption beyond current expectations. Notably, a technical US recession or slowdown alone may not significantly alter the default outlook unless it drives a reassessment of broader credit conditions.
• Inflation resurgence, which remains the most direct threat to the demand for yield. In a stagflationary environment, asset allocation becomes more difficult—but high yield, with its relatively low duration and currently low default rate, could remain a competitive option.

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

 

Assumptions, opinions and estimates are provided for illustrative purposes only. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, and the investor may get back less than the original amount invested. There is no guarantee that any forecasts made will come to pass.

[1] Source: Bloomberg as at 13 June 2025.