While geopolitical and fiscal challenges abound around the world, credit markets continue to perform well, showing undeniable resilience both in terms of their performance and the continued inflows into the asset class.

After three years of almost uninterrupted rallying, credit spreads are raising questions: everyone agrees that they are expensive! Should we therefore take a contrarian approach to these credit premiums? Or, on the contrary, take advantage of the recent October correction to increase allocation to the segment?

Solid fundamentals but vigilance is required

In Europe, this compression in spreads undeniably reflects the solid fundamentals of companies, which have taken advantage of the post-Covid years to strengthen their balance sheets and thus prepare themselves to weather a period of slower growth without disruption. Debt ratios have normalized after the pandemic, returning to below 4x net debt/EBITDA on average, a level still far from the pre-pandemic peak. Above all, default rates remain contained: below 2% in Europe for high yield, compared with around 3-4% in the United States, a level still well below the alert thresholds for the markets. It should be noted that the majority of these "defaults" are in fact debt restructurings, with very high recovery rates (the portion recovered by creditors) of around 65-70% on average, compared to 30-40% on average over the long term, which greatly limits potential losses for bondholders. This resilience can be explained by issuers' prudent balance sheet management and effective anticipation of refinancing needs thanks to sustained activity in the primary bond market, but also by increased diversity in funding sources.

Signs of stress emerged in October from the private credit market in the United States. Recent bankruptcies (First Brands, Tricolor) have exposed risky lending practices, and these events, although contained so far, raise questions about the quality of underwriting in a rather opaque segment... which issuers have made extensive use of in recent years. While these alternative financing options have so far provided support for "traditional" bond markets, a continuation of defaults could ultimately lead to a more brutal repricing of these same markets.

A still dynamic primary market

Primary market activity remains robust, with 2025 shaping up to be a record year in terms of new issues in Europe, with more than €600 billion issued in Investment Grade and more than €140 billion in High Yield. Appetite has been enormous throughout the year, fueled by continuous inflows into the segment, particularly in specialized funds. This inflow does not seem likely to slow down in the short or medium term: investment flows remain focused on the search for yield, with Euro Investment Grade offering 3.0% and Euro High Yield 5.0%. These yields are well above their historical average, offering a still appreciable surplus compared to money market funds, which are now below 2% in Europe.

The average yield on the Euro IG remains well above its average for the last 10 years. This is also the case for the Euro
HY, although the gap has narrowed significantly since 2022. Source: Mandarine Gestion.

Valuation faces the reality test

While Investment Grade sometimes appears to be almost safer than (certain) government debt, it should be noted that the safety margin has narrowed considerably. With European spreads below 80 basis points, a widening of 10 to 15 basis points over twelve months would now be enough to wipe out the relative carry and make sovereign bonds more attractive. Any exogenous shock could therefore be poorly tolerated. The negative reaction of spreads to the announcement of US tariffs last April (+21 basis points in one week) illustrates a certain vulnerability which, on this occasion, did not prove to be lasting.

Furthermore, the macroeconomic environment remains uncertain. Europe remains caught between US protectionist policy, which is reducing exports to its destination, and China's aggressive policy, which could potentially increase imports of forced deflation. The ECB is currently maintaining its rates at 2% and still has room for maneuver should growth and/or inflation fall too low in 2026. But conversely, if the stimulus plans announced in the first quarter take concrete shape and defy the skepticism currently shown by the markets, long-term government bond yields should come under pressure again , making them potentially attractive once more... to the potential detriment of credit with overly tight spreads.

Outlook for 2026: between opportunities and... better opportunities!

In 2026, the European credit market will therefore certainly evolve in a more volatile environment than in 2025. European growth is expected to improve, with forecasts revised above 1% for 2026 and potentially, if stimulus plans become clearer, above 1.5% for 2027. Demand for corporate bonds should therefore remain buoyant, supported by attractive yields relative to monetary rates. However, the narrow spread with government bonds and, above all, the lack of a "safety cushion" against shocks that could come from the United States, where the macroeconomic outlook remains highly uncertain, should lead to more waves of breathing space in these spreads, creating entry points that are more attractive and protective than the current ones.

While carry trades remain relevant for medium/long-term investment horizons, flexible management and absolute return strategies, such as Mandarine Credit Opportunities, are particularly appropriate. In an environment where the ability to identify pockets of value and quickly adjust exposure to different market segments will be crucial, this fund offers an ideal complement to a bond portfolio.

With no benchmark constraints and the ability to invest across the entire credit spectrum (investment grade, high yield, subordinated debt), while remaining highly mobile in terms of sensitivity to movements in government bond yields (Euro and US), the fund should enable investors to capture market inefficiencies while controlling risk and limiting the downturns expected in 2026.

Completed on November 4, 2025

Credit: a market that is too complacent in the face of economic realities?

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