Navigating the Selective Strength of Credit Markets

The optics of Resilience

At first glance, the credit landscape today exudes stability:

• Yields remain elevated across both U.S. and European markets, offering attractive carry for investors in both Investment Grade (IG) and High Yield (HY).
• The fundamental backdrop has—so far—held firm. First-quarter earnings were broadly stable, and although Q2 clarity remains pending, default rates have stayed subdued, and rating migration has not shown alarming trends.
• Technical are equally constructive. Following the "Liberation Day" outflows earlier this year, flows have returned with force, not only recovering prior losses but exceeding them. In IG credit, record issuance was largely well absorbed by investors, while issuance in HY remained muted, lending natural support to spreads.
• Central banks have provided a helpful backdrop. The European Central Bank has decisively eased, while the Federal Reserve appears poised to begin its long-anticipated easing cycle, now that inflation is approaching levels compatible with a cautious rate cut.
• Fiscal policy has also added fuel to the fire: the U.S. continues to deploy substantial government support via the “Big Beautiful Bill,” while Germany has proposed a meaningful stimulus package. Growth, on the surface, may well surprise to the upside. So—why worry?

Complacency in the Face of Complexity

Beneath the surface calm lies a thicket of uncertainties that markets appear too willing to ignore. Chief among them is the ongoing tariff war, an unresolved geopolitical fault line that continues to cast a long shadow. With a new deadline approaching in August and little visibility on the structure or substance of any eventual trade agreement, the macro landscape remains cloudy. This opacity is particularly consequential for inflation—a central concern for the Fed—which remains hostage to unpredictable tariff dynamics.

While the consensus still leans toward easing, Fed rhetoric is increasingly fragmented. Meanwhile, political interference—most notably President Trump’s pressure on a nominally independent Fed—has not gone unnoticed, injecting another layer of unpredictability into monetary policy outlooks.

Moreover, the much-lauded fiscal stimulus may be less potent than headlines suggest. In the U.S., a large share of the package simply extends existing tax cuts rather than injecting fresh capital into the economy. Corporates, already contending with high refinancing costs and policy uncertainty, are unlikely to ramp up capital expenditures under these conditions.

Play the geographical differentiation: A shift in favour of Euro Credit

One of the most persistent misconceptions about credit markets is the assumption that they are uniform, homogeneous, and largely synchronized. Many investors tend to speak of “credit” as a single asset class, lumping together geographies, sectors, maturities, and even instruments. In truth, credit markets are anything but monolithic. They are complex, fragmented, and full of dispersion—offering a rich and varied landscape that rewards selectivity and careful calibration.

Currently, one of the clearest examples of dispersion lies in the transatlantic divergence between U.S. and European credit markets. On nearly every front, European credit presents a more compelling case.

Valuations are particularly attractive in Europe. Despite the European Central Bank having already cut rates eight times over the past 18 months, Euro IG credit still offers yields around 3%, while Euro HY delivers north of 5.5%. When accounting for currency hedging costs, U.S. IG and HY yield just 2.7% and 4.7%[1] respectively for Euro-based investors. In terms of pure carry, European credit clearly holds the upper hand.

Credit yields are still attractive

Fundamentals also favour Europe. Rating drift has been more positive in Euro credit markets, with a greater number of upgrades than downgrades. The rising stars—issuers transitioning from HY to IG—outnumber fallen angels, the reverse transition. Furthermore, Euro HY has a higher proportion of BB-rated debt, versus the U.S., which is more skewed toward B and below. Leverage levels are generally lower in Europe, and free cash flow generation remains solid, painting a healthier credit picture overall.

Technical factors reinforce this view. Euro IG credit has attracted meaningful inflows, as investors begin reallocating from U.S. to European credit segments. Meanwhile, issuance in the Euro HY space has been relatively subdued, supporting market dynamics through reduced supply pressure.

Beyond Geography: Differentiation at sector level

However, regional differences are only one piece of the puzzle. Sector selection is critical. Different sectors exhibit varying sensitivities to macroeconomic trends, geopolitical shifts, and cyclical pressures.

• TMT (technology, media, and telecom) and healthcare sectors tend to be more resilient in volatile environments, while more cyclical industries like autos and retail remain vulnerable to changes in consumer demand, trade policy, and supply chain disruptions.
• The energy sector, influenced heavily by commodity prices, is currently challenged by a weaker macro-economic backdrop and lower oil prices.
• The packaging sector on the other hand represents a unique opportunity set, thanks to its oligopolistic nature (being highly concentrated and benefiting from pricing power).

Capital Structure also matters: The case of financial debt

Capital structure adds another layer of selectivity. Within a single issuer’s debt stack, subordinated debt and hybrid instruments have stood out in the current environment. These instruments often provide higher yields without proportionately higher credit risk, particularly when issued by high-quality corporates. For investors comfortable navigating structural complexity, such positions offer compelling risk-return profiles.

Bank subordinated debt in Europe currently presents an attractive investment opportunity, offering yields in excess of 5%[2]—a level of carry comparable to that of European high yield bonds in the BB segment. The asset class is underpinned by solid fundamentals, with banks demonstrating robust return on equity, strong capital buffers, and healthy interest coverage ratios. Moreover, issuance levels remain moderate and are being well absorbed by the market, reflecting sustained investor demand. As such, subordinated bank debt offers a compelling bridge between investment-grade and high-yield credit, combining quality with enhanced return potential.

The Case for Selectivity

In a world where central bank support is no longer omnipresent and credit conditions are increasingly dictated by idiosyncratic rather than systemic factors, investors must abandon blanket approaches to credit allocation. The “rising tide lifts all boats” phase is over; dispersion has returned, and with it, the need for skillful picking.

This new era of credit investing is less about making broad beta plays and more about navigating granularity—choosing between regions, sectors, maturities, ratings, and instruments with precision. Active managers with deep research capabilities are well-positioned to take advantage of the current environment by identifying mispricings and positioning portfolios to benefit from relative value across sub-asset classes.

Being selective is no longer optional; it is essential. Calibrating exposure thoughtfully—across geographies, sectors, maturities, and structures—offers the best path toward resilient and consistent credit returns. In this environment, differentiation isn’t just a feature of the market—it’s the strategy.

[1] Source: Candriam, Bloomberg, data as of 30/06/2025. Euro Investment Grade: ICE BofA Euro Corporate, Euro High Yield: ICE BofA Euro High Yield, US investment Grade: ICE BofA US Corporate, US High Yield: ICE BofA US High Yield
[2] Source: Candriam, Bloomberg, Data as of 30/06/2025, ICE BofA Contingent Convertible Index