We cannot ignore the dominant themes impacting markets across the world, but a resilient and supported European marketplace is well placed to prosper in these challenging times.
European high yield (EHY) continues to offer attractive elevated yield levels (6+%) with high breakevens and relatively low duration (less than three years). This means that, if we were to see a sharp rise in government yields, returns should be more stable compared with other fixed income asset classes.
Although credit spreads are inside their long-term average, technicals have been – and will likely continue to be – supportive of the market. Investors are still seeking yield, leading to good inflows into the asset class (around €2.1 billion year-to-date). A recent notable increase in the primary market (€47 billion year-to-date) has also been positive, since it provides new investment opportunities through new issuers. Any market attempt at a sell-off has been quickly halted by strong demand, as we saw in the latter part of April following the tariff announcements by President Trump.
Overall, corporates are showing solid balance sheets with improved levels of leverage, which have reduced in recent years. This has also been supportive of the tighter credit spreads. With money market rates having fallen, and at least another rate cut expected of the European Central Bank, this should continue to be supportive for corporate bonds as investors look to deploy their cash.
Driving forces
The increased interest rate differential between the Europe and the US is supporting interest in EHY. Hedging US dollar-denominated assets back into euros has become very expensive. This makes euro-denominated paper more attractive. As such, we are seeing renewed interest from investors from outside Europe.
We do not see the US dollar having a huge influence on the EHY market. Yes, uncertainty in the US from the current administration does make foreign investors more likely to look towards Europe for new investments, and in the longer term the euro/US dollar level might have an impact on competitiveness if the euro is too strong, but this is not the case at the moment – the widening interest rate differential is the more immediate focus.
Underweights and overweights
The uncertainty triggered by Trump’s tariff announcements, as well as the subsequent back and forth, has created a lot of uncertainty. Companies are finding it difficult to have a clear view of the potential impacts on their business. As such, particularly for global sectors such as automotives and chemicals, the market has been very volatile over recent months. The concern is that growth and their top line as well as margins will be impacted. We have taken advantage of some of that volatility to add to specific names, especially those with low leverage and good capacity to withstand potential impacts. Other sectors that are more domestic and should be less exposed – such as leisure, utilities, real estate and healthcare – are generally areas in which we are overweight (as at the end of May).
Sectors where we are more cautious and underweight include retail, energy, transportation and capital goods. Often these have somewhat weaker balance sheets or face fierce competition, for example in food retail, which puts margins under pressure.
Looking through 2025
With the ECB likely to bring interest rates lower still, and with inflation under control and spreads tight, we believe returns will be near the yield – around 4-5% over the coming 12 months. That is, as long as we don’t see a major sell-off in wider risk markets. The one-to-three-year yield, now in the 5% range, is back to levels seen around five years ago (Figure 1).
Figure 1: Tracking down
European High Yield index, 1-3-year yield (%)
Source: ICE BofA BB-CCC1-3 year Euro Developed Markets HY Constrained (H1EC), as of 31 May 2025
From Covid through to the cost of living crisis, the high yield market saw more rising stars (firms that improve their credit ratings to become investment grade-level bonds) than fallen angels (bonds previously classified as investment grade that have been downgraded to junk status).Since 2023, however, this trend has reversed and market expectations are now more for fallen angels than rising stars. In fact, when we look at the market and at credit ratings, trends and company operations we see a risk of as much as €27 billion of fallen angels. For example, we have just seen Warner Brother Discovery1 come to high yield (they have some euro-denomination bonds, but most of their debt is in US dollars).
However, we have also seen some rising stars (and expect to see some more), such as Italian digital payments company Nexi, which is a stable business with strong cashflows. This might become a more meaningful number if the economic outlook continues to remain stable.
The bottom line
Tariffs remain the dominant theme within markets. Uncertainty has undoubtedly increased, and a number of issuers have withdrawn guidance due to ongoing uncertainty, something that is especially notable in the autos sector.
But we shouldn’t forget that in Europe at least there are two notable tailwinds: lower interest rates, and the German spending package for defence and infrastructure, which should have a positive stabilising impact on growth in Europe, albeit likely moderate. In addition, many companies have solid balance sheets, good liquidity, improved lower leverage levels and decent operations, so should be able to weather the storms – and, candidly, are adept at doing so having navigated multiple headwinds in recent years. We would expect them to do so once again.
