Link para o artigo original: https://www.man.com/maninstitute/2025-credit-outlook-changing-of-the-guard
Our credit teams outline their expectations for the year ahead, in the face of shifting sands for geopolitics and credit markets and the expectation of ‘higher for longer’ interest rates.
December 2024
In focus
Bracing for elevated rates
Markets were euphoric in September after the Federal Reserve’s (Fed) eagerly awaited first interest rate cut since 2020, largely seen as a signal of the Fed’s increased confidence in having tamed inflation. We have long stated that we do not expect a return to the zero-interest-rate policy of the past decade. However, with growth resilient in many markets and in light of the election of Donald Trump as US President, we believe the speed of cuts is likely to be shallower than the market expects.
US inflation is already showing signs of lingering above the Fed’s 2% target, with the easy gains now gone. We expect it to rise as a result of more inward-oriented US policy under the new president. This is likely to further limit the ability of central banks to cut aggressively and will put upward pressure on interest rates. In short, investors — and issuers — need to be prepared for an environment of higher interest rates for longer.
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A tug-of-war
The market is continuing to grapple with a tug-of-war between attractive yields and tight spreads. The election of Trump prompted a revival of animal spirits and a remarkable rally in credit, with US investment grade markets touching an all-time tight of 73 basis points (bps). Strong growth, positive technicals and limited refinancing pressure may help to explain tight spreads, and it could also be argued that comparing spreads to history makes little sense given compositional differences, particularly in high yield.
Regardless, we assume spread tightening from here will be limited, leaving passive investors with, at best, a carry opportunity set. Wider spreads in the coming year could subject these investors to losses. We expect dispersion to accelerate, with winners and losers emerging in the new regime. In general, we find small- and medium-size issues more attractive. They tend to trade with greater dispersion, and therefore present more security selection opportunities than the larger issues in the market, which are often overrepresented in indices, as shown in Figure 3.
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A higher-for-longer backdrop will also have a dramatic impact on company fundamentals. Broadly syndicated loans (BSLs) have already faced the brunt of higher interest costs, but high yield companies — particularly those that issued debt post-COVID — have benefitted from an environment of relatively low interest costs. Corporate chief financial officers will need to reflect on the reality of higher rates for longer and will face elevated maturity walls. We expect to see difficulties in more cyclical sectors and believe that liability management exercises and outright defaults may increase in the future.
Size matters in the direct lending market
Turning to private credit, recent headlines lament a fast and furious spread compression. Notably, much of the impact has been focused on the upper middle market, where the largest borrowers with US$100 million+ in earnings before interest, taxes, depreciation and amortisation (EBITDA) have pitted private lenders against the BSL market. Meanwhile, direct lending to the core middle market continues to offer investors significant yield pick-up relative to the BSL market, with much of this attributable to higher spreads, a topic explored in greater depth in a recent paper authored by Man Varagon.
Against this backdrop, we believe a careful approach to credit selection in both public and private markets, characterised by fundamental analysis and close attention to detail, will continue to be key in 2025.
In brief
In depth
At Man Group, we have no house view. Portfolio managers are free to execute their strategies as they see fit within pre-agreed risk limits. With that in mind, click below to expand the 2025 outlooks from our different credit teams.
Public Markets
Systematic Credit
The US election sparked a risk-on rally that drove credit dispersion levels to historic lows. Meanwhile, the media, telecoms and leisure sectors continue to see elevated dispersion. We believe credit markets are currently grappling with how to balance the goals of the incoming Trump administration against what can realistically be achieved.
Figure 4. Option-adjusted spread dispersion by sector
Source: Man Numeric and ICE BofA, as of 30 November 2024.
Following the risk-on rally post-election, which has seen lower quality companies outperform thus far, 2025 could also see a return to the longer term expectation of higher quality companies outperforming, especially if inflation remains stubborn and negatively impacts the companies with more debt on their balance sheets that we tend to avoid.
We believe balanced investment approaches will be better positioned to navigate uncertain credit markets. Risk control will be critical during periods of inevitable volatility – whether it be driven by geopolitical, economic, or other factors. We are increasingly able to apply systematic processes to segments of the fixed income market beyond high yield and investment grade which have historically been the focus for quants.
Global Investment Grade
While we do not yet know US policy specifics, a series of themes for investment grade credit in 2025 are emerging. Beginning with tariffs, talk of 60% tariffs on China in Trump’s pre-election campaign may prove to be a negotiating tactic, but higher levels than those in place today are expected. Mexico and Canada are likely to feel the brunt of a protectionist America too. We have been heavily underweight automotives and broader manufacturers for over a year due to the overvaluation of cyclical sectors. The outcome for services is less clear, but we continue to favour financials, particularly in Europe, where we believe the profitability of certain banks will remain healthy despite an uptick in loan book losses.
Another important theme is deregulation. Earlier this year, the UK opted to water down proposed banking regulations in a bid to support growth. The new US government could opt to weaken anti-trust rules while a soft landing could incentivise companies to be even more aggressive with their balance sheets, both of which could heighten animal spirits and spur heightened levels of mergers and acquisitions (M&A).
At this point in the cycle, we believe it remains prudent to have a low credit beta compared to the wider markets, while still focusing on selecting securities which can provide a higher yield carry than standard market benchmarks. We aim to not take significant active duration views, but due to the supply-demand imbalance between increasing government debt issuance coupled with modest appetite from investors, we could see more volatility going forward from the rates market, particularly in longer-dated securities.
Global High Yield
‘Higher for longer’ typically equates to rising defaults in sub-investment grade credit. However, there are several factors which may keep bankruptcies in check. Firstly, a resilient US economy may give issuers the revenue streams they require to offset higher borrowing costs. Secondly, fundamentals remain robust – both leverage and interest rate coverage ratios are at mid-cycle levels. Finally, the quality of the market has been improving over the years, as more highly indebted firms opt to finance themselves in the leveraged loan markets, which are experiencing higher levels of default than fixed-rate high yield for the first time ever.
With a focus on 2025, one factor which we believe is not being as widely discussed as it should be is the impact of potential US immigration policies on future employment or growth. Immigration has been a major driver behind the growth of the US labour force and stricter measures related to this may lead to potential headwinds for overall growth in the coming 12 months.
Given the rally in US credit, we continue to favour Europe, with a focus on the shorter-dated part of the market. A significant proportion of the high yield market, particularly the BB space, trades at a spread of below 300 basis points. This will be an area that we will continue to avoid, given poor convexity. However, this masks the idiosyncratic opportunities which remain prevalent at spread cohorts above these levels, particularly in small- and medium-sized issuers. All-in yields remain elevated compared to post-Global Financial Crisis (GFC) levels and as the duration of the market has dropped, the overall breakeven of the asset class (the amount of spread or yield widening required to lose money on a forward-looking 12-month basis) is at a high level compared to history. In particular, we are remaining active in stressed refinancing and liability management exercises (LME) with a specific focus on business models with hard assets.
Collateralised Loan Obligations (CLOs)
2024 saw record issuance of new issue US and euro CLOs. Liability spreads tightened significantly across the stack, highlighted by AAAs compressing by approximately 40 bps in both the US and Europe. We expect the risk-on rally in CLO liabilities and CLO assets, mainly loans, to continue into 2025. Already tight asset spreads, resulting in rich valuations, cannot continue to tighten forever and still be attractive assets for CLO formation. In 2025, there may be an asset-price correction driven by any of a number of factors such as valuations, trade policy, long-rates, geopolitical uncertainty or other macroeconomic factors. Assuming loan spreads widen more than CLO liability spreads, the CLO arbitrage spread will be supportive of a strong year of continued CLO formation.
Leveraged Loans
In 2024, the US market saw record loan issuance with minimal net new supply, primarily due to significant loan refinancing and repricing activity. Strong demand from new CLO formation and retail ETF and fund inflows, driven by loans’ higher carry and floating rate nature, has created a technical imbalance which we expect to support loan prices through year end and into 2025. We anticipate a moderate decrease in gross loan issuance in 2025, but a significant increase in net new issuance, aided by lower rates and US election-driven deregulation and tax cuts. This should be well absorbed by the market. Resilient economic data, solid corporate fundamentals and limited near-term maturities should support a high single-digit coupon clipping environment, though tariffs, policy uncertainty and potential reinflation pose risks to certain single names and sub-sectors, in our view. Loan defaults are expected to moderate in 2025, but LMEs will continue to have an impact. The US investment team prefers mid-single B-rated risk profiles and remains cautious on pre-LME CCCs and low-quality single B-rated loans.
Turning to Europe, euro CLOs form upwards of two-thirds of loan demand and will drive demand for additional loan issuance. We expect continued interest rate declines in Europe (3-month Euribor -100 bps year-on-year and 5-year bunds -40 bps year-on-year) to continue to bring buyers and sellers closer on price and therefore result in increased new loan supply. As the euro loan market grows, more new deals mean that the credit quality of first-time issuers is more opaque and may be a source of performance dispersion. The majority of loan issuers are single-B rated and only a small deterioration in credit performance can cause downgrades to CCC. Loan prices gap downwards significantly when downgraded from B to CCC.
In addition to ever-present idiosyncratic risk in Europe, the macroeconomic outlook is one of decreasing confidence in economic growth due to sticky wage inflation, increased tariff risk from the US and sovereign deficit limit breaches, such as in France. While the lower Euribor impact on borrowers’ interest burden is welcome, revenue and EBITDA performance will remain the more important arbiters of loan prices, as well as the risk of LMEs. If LMEs materialise in size, causing meaningful credit losses for CLO investors, it could upset the long-term profit trend seen by CLO investors and therefore growth in the asset class. This is the challenge European loans face in 2025.
Emerging Market Debt
A Trump presidency and Republican Congress pose significant headwinds to emerging markets (EM) fixed income through tariff policies, geopolitical shifts and domestic policies that are leading to a stronger US dollar and higher interest rates, potentially triggering a hard landing. Geopolitics remains a key risk, as the Ukraine conflict could worsen before it concludes, despite Trump’s promises; tensions between Israel and Iran could escalate; and Taiwan could become a point of focus.
Tariffs and currency (FX) depreciation are likely to limit improvements in EM inflation, which might have benefited from moderating services inflation. This constraint reduces the scope for EM monetary policy easing going forward, resulting in less synchronised policy changes as EM central banks navigate changing US financial conditions, domestic financial stability concerns and diverse exposures to international trade. Although local yields for JP Morgan Government Bond Index-Emerging Markets (GBI-EM) countries appear high and real rates are attractive in many cases, the overall differential to US yields at 235 bps (17 bps tighter year-to-date) remains at historical lows, offering little cushion against a further sell-off in US rates.
EM FX valuations have selectively improved over the past few months amid uncertainties surrounding the US election, China, and the global economy, along with improvements in current account balances, with the weighted current account of the countries in the GBI-EM Global Diversified (GD) Index back to equilibrium. Overall, EM FX1 has weakened 6.2% in nominal terms in 2024 year-to-date. This, along with lower EM inflation, has helped correct the overvaluation of some higher-yielding currencies, such as the Mexican peso, Colombian peso and the Brazilian real. We anticipate that valuations might become even more attractive before rebounding since risk sentiment is likely to deteriorate as the priorities and timeframes of the next US administration become clearer in the first quarter of 2025.
In the external sovereign market, EM sovereign credit spreads have continued to tighten both before and after the US election, absorbing much of US Treasuries’ repricing, despite historically tight levels. The JP Morgan Emerging Markets Bond Index (EMBIG) headline spread at 302 bps is 17 bps tighter year-to-date, but this figure understates the extent of the tightening due to the inclusion of Venezuela in the benchmark in the second quarter of 2024. Excluding defaulted Venezuela, the EMBIG spread stands at 242 bps, which is 77 bps tighter year-to-date and at historical lows. The high absolute yield levels mask these tight valuations. However, the focus on yield over spread is based on assumptions of a Fed cutting cycle and a soft landing. We see risks skewed toward significantly wider spreads next year due to increased core rate volatility, signs of reaccelerating inflation in the US, geopolitical tensions and the risk of a trade war increasing the likelihood of a hard lending, while future gains depend on continued declines in US Treasury yields.
Emerging Market Corporate Bonds
Global credit markets will enter 2025 with a high degree of uncertainty, particularly EM credit, where momentum is caught between the world’s two largest economies. There are several key factors to keep in mind. After a drop in interest rates in 2024, it is uncertain whether US Treasury rates will fall or rise in 2025 due to persistent inflation. Adding to this uncertainty are historically tight spreads; a new US administration with fresh policies; uncertainty about commodity prices driven by China’s supply and demand; the possibility of tariffs on goods and services worldwide; and geopolitical tensions in almost every region. We think these uncertainties will create clear winners and losers within EM which should create an attractive opportunity set for active investors.
The good news is that the EM credit universe is starting from a strong base. Net leverage currently sits at an average of 1.6x, while liquidity is stronger with a cash-to-total-debt ratio of 40%. High yield defaults remain stable at around 2.5%, having peaked earlier than developed markets where we would expect accelerating levels of defaults. Looking forward, hard currency issuance is set to increase across all regions, with the Bank of America (BofA) predicting a 17% rise, but technicals remain supportive with relatively anaemic net issuance over the past three years.
Spreads are currently very sticky across EM corporate markets and we believe the better carry offered by high yield debt could cause lower-rated portions of the market to outperform. However, the real value will likely lie in security selection as different regions fall in and out of favour and changing global trade policies materialise. We maintain a preference for opportunities in Latin America, in particular Brazil and Argentina, where we think value remains attractive, while we are cautious about some issuers in Mexico. Additionally, we are finding some attractive special situations and stressed opportunities in Asia, but remain cautious overall with limited directional exposure in China.
Asia Credit
Asian investment grade and high yield debt are on track to outperform their EM and developed market peers in 2024 as a result of better spread performance and lower sensitivity to US rates headwinds. We expect this strong performance to continue in 2025, given strong fundamental credit momentum across both Asian sovereigns and corporates.
Moody’s predicts that the three countries with the highest real GDP growth rate will all be from Asia: India, Indonesia and China. Further, Asia Pacific (ex. Japan) sovereigns registered the lowest percentage of downgrade/review ratings in 2024 among all EM regions.
Turning to sector specifics, we expect Asian financials to outperform Asian non-financials and prefer sectors focused on domestic consumption as we believe they are more likely to be supported by governments’ easing measures and less impacted by potential trade tariffs. From a regional point of view, we continue to favour Japanese credits, especially Japanese insurance companies as we believe they will benefit from Japanese rate tailwinds and favourable Japanese economic momentum.
Potential trade tariffs and geopolitical risks are major overhangs to global credit and Asia is no exception. However, we believe the market has already factored in a greater impact on Asian credit compared to its peers, while issuers in Asia have more capacity to handle a shock with their strong credit metrics and more favourable bond demand/supply dynamic.
Contrary to what some may think, we believe a stronger dollar, a higher-for-longer environment and all-in-yields above the historical average are beneficial technical aspects of Asian US dollar credits and may encourage local and international allocators to increase their exposure.
We anticipate more idiosyncratic opportunities will emerge as Trump policies will likely prompt a rotation to domestically driven credits in Asia.
Convertible Bonds
2024 has been a year of two halves for global convertible bonds (CB). In the first half, the asset class saw very modest single digit gains, underperforming global equities which were dominated by a handful of mega-cap shares. In the second half, however, softer-than-expected inflation prints led investors to price in less restrictive monetary policy and the decline in yields supported a rotation from mega-caps into small- and mid-cap stocks, helping to drive meaningful gains for convertibles.
In the primary space, activity has been very healthy, but is once again dominated by the US. Overall volumes in 2024 have exceeded US$100 billion, up more than 45% on 2023 and almost 200% on 2022 levels. Refinancing has been a key theme as firms seek to address the hefty pandemic-era maturity wall while the elevated rates environment has also spurred companies to reduce interest expenses with convertibles. Finally, the quality of the asset class has improved this year with nearly 25% of primary volumes carrying an IG rating.
Turning to 2025, the asset class will remain sensitive to US domestic policies, given that CB issuers typically fall into the small- and mid-cap bucket, and have a strong focus on the US market. Since the US election, valuations for CB issuers have expanded as the market prices in pro-growth policy benefits such as tax cuts and deregulation.
We are optimistic about the ongoing small-cap rally and we believe we are at a pivotal moment in market leadership. Today the US equity market is more concentrated than it has been in a century and we think this may be unsustainable. With major global economic shifts in inflation and interest rates, now presents an opportunity for portfolio rebalancing and we believe the best opportunities lie in the small to mid-cap segment, which aligns with the convertible bond asset class.
The recovery in M&A we are witnessing represents another tailwind for convertibles. Trump’s election and lower rates are expected to sustain this positive trend as regulations ease and companies deploy their cash reserves. With small- and mid-cap companies still cheaper than large caps, convertible issuers are well-positioned to gain from increased takeover activity, in our view.
The main risk for convertibles in 2025 is a potential global recession. This could hinder firms’ ability to refinance debt and push up default rates. The impact would depend on interest rates, however; aggressive rate cuts could help longer-duration convertibles but might also negatively affect credit spreads and sentiment. Conversely, persistent high rates due to stubborn inflation could put pressure on firms which still need to refinance pandemic-era debt. However, these rates could encourage crossover issuers to consider convertibles for their cost benefits.
Catastrophe Bonds
The outlook for the catastrophe bonds (cat bonds) remains positive as we head into 2025 with sustained interest from new and repeat sponsors, as well as continued inflows of alternative capital. The reinsurance industry remains well-capitalised and has experienced strong returns to date. Cat bonds saw a record amount of issuance in 2024, and this trend is expected to continue with high sponsor demand and a heavy maturity schedule driving further issuance. Activity during this year’s Atlantic hurricane season turned out to be at the lower end of meteorologist forecasts. Nevertheless, the events were sufficient in number and intensity that insurance rates remain hard. Cat bonds’ market cap reached an all-time high and, while returns in 2024 did not match the outsized returns of 2023, investor interest remains solid.
Broadly, supply and demand is in equilibrium in the space, although we have noticed some distortion in industry index deals with strong investor interest. The generally hard market means that the return per unit of risk of deals has remained supported. Cyber as a peril first emerged in public cat bonds in 2023 and has grown further this year. Over the medium term, we see it possibly emerging as a third peak peril, offering additional capacity and diversification from US wind and quake. We were pleased to see France come to market for terrorism cover, but expect this to remain a secondary peril, which will not appeal to all investors.
Private Markets
Middle Market Direct Lending
We expect large borrowers to continue to pit upper middle market lenders against the syndicated loan market in 2025. In contrast, we believe core middle market lenders will continue to benefit from an attractive spread and strong financial covenants which enable them to bring borrowers and sponsors to the table at the first signs of trouble.
In the face of higher-for-longer interest rates, we anticipate that core middle market lenders focused on companies with strong cash flow generation, continued solid growth, and which operate in non-cyclical, recession-resistant or recession-resilient sectors, will continue to generate attractive unlevered returns. However, higher-for-longer rates will continue to add expense pressure for select borrowers, particularly those who are highly levered and/or experiencing weak operating conditions.
In a world of heightened regulatory and geopolitical uncertainty, a strong focus on businesses and sectors with low ‘stroke-of-pen’ or regulatory risk, as well as businesses with a diversified consumer base and supply chain, are better positioned to navigate the potential negative impacts from sudden regulatory changes, higher tariffs and the resulting inflationary pressures, in our view. We believe credit selection will continue to be the key driver of alpha generation in 2025.
US Residential Credit
Barring a large unforeseen macro event, or significant policy change under incoming President Trump, we expect 2025 will see a continuation of 2024 themes in the US housing and mortgage markets.
National home price appreciation (HPA) stands at 3.5% year-to-date and the 30-year conforming mortgage rate at 6.7%. Looking ahead to 2025, it feels fair to assume that HPA will remain at or close to the long-term average of 4%, range bound by the competing pressures of unaffordability and limited supply. The potential for inflationary policy change and higher-for-even-longer implies that mortgage rates are unlikely to fall significantly next year, with J.P. Morgan forecasting 6.4% by the third quarter of 2025. This would extend the lock-in effect that has been a key driver of the lack of supply and low transaction volumes. Over 80% of mortgages have interest rates below 6%, creating a disincentive to move until the mortgage rate starts with a five or lower.
This presents a frustrating picture for renters looking to buy, or growing families upsizing their homes (ignoring the very strong equity position current owners find themselves in). However, it is positive for residential credit investors, who have an attractive opportunity to lock in investments at higher-than-historical interest rates and to generate equity-like returns from loans with conservative leverage, medium-term duration and structural protections, collateralised by real estate assets that are expected to appreciate further in value.
Credit Risk Sharing (CRS)
Investors seeking higher yields have favoured significant risk transfers (SRT), a form of securitised CRS, in a year when more traditional, liquid credit markets have been characterised by persistently tight spreads. Indeed, the SRT market shows strong growth fundamentals. Pitchbook data indicates the market is set to reach an estimated US$28-30 billion of issuance in 2024, versus a then record US$24 billion issued in 2023. With over 70 banks now having active SRT programs, and more coming online in Europe and the US, we see this rapid growth trajectory continuing in 2025.
Importantly, we have seen a shift in narrative over the past 12 months, with banks viewing SRT issuance as a means of enhancing capital efficiency, rather than just an alternative to equity. Going forward, this narrative should be supported by favourable regulatory developments and the persistently high cost of capital alternatives for banks in the current market environment. Above all, banks will continue to prioritise increasing their capital ratios.
However, SRTs are likely to become more expensive for issuers. Despite the regulatory concessions, banks could need to sell thicker tranches to achieve capital relief under the final Basel III standards. In addition, as SRT supply increases, transaction pricing may not remain as favourable to issuers as it has been so far this year. Wider spreads would be eagerly welcomed by the market. From an investor perspective, should spreads widen while the market is still expanding rapidly, we believe it will be experience, underwriting and structuring capabilities that lead to consistent yields and cedit performance.
1. As measured by J.P. Morgan GBI-EM Global Diversified FX return.
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