Despite stretched valuations, European corporate bonds continue to benefit from solid fundamentals. Is this asset class still attractive in an environment marked by global economic uncertainty and unexpected market movements? Analysis and outlook.

Since the sudden rise in interest rates in 2022, credit spreads (the additional premiums offered by private issuers to compensate for the risk taken compared with government rates) have narrowed almost continuously since their peak in October 2022. This decline reflects both an improvement in the credit quality of issuers and greater confidence in the economic situation, which will finally have avoided a recession, as well as the attractiveness of an asset class with an interesting risk-adjusted return profile that has rewarded investors handsomely since 2022.

Hitherto immune to virtually all events on the financial markets since 2022, spreads reacted very negatively, as did all risky assets, to the tariffs announced by Donald Trump on 2 April. In less than a week, Investment Grade spreads widened by 21bp (a 25% increase in the risk premium) and High Yield spreads widened by more than 50bp (a 37% increase in the risk premium).

Source: Mandarine Gestion. (*) Percentile = % of daily observations lower (spread or yield) than the daily observation since 2009.

Do recent developments signal the end of a golden period, to be replaced by an increase in the risk of default, or are they an attractive entry point?

Valuations are historically high

Leaving aside the early 2000s, when credit spreads were artificially squeezed by the rise of highly leveraged instruments, there have rarely been periods when spreads were lower than at the start of 2025, when they began at 100 bp against government rates. Between 2009 and 2025, these Investment Grade credit premiums were below 100 bp in only 20% of daily observations. In historical terms, spreads are therefore tight and unattractive. The widening that followed on 2 April makes the observation less harsh, putting spreads closer to their long-term average (around 120 bp against government rates), i.e. at a percentile of 40% as at 7 April.

In line with improving fundamentals

If we look at the current average viability of European issuers, whether Investment Grade or High Yield, and their ability to service their debt over the medium term, recent valuations seem rather justified. The Covid years of extremely low interest rates have enabled issuers to refinance at low cost over the long term. As a result, Europe's debt and interest coverage ratios are very good, and there is no reason to expect a sharp rise in the default rate over the next two years. This is all the more true given that the German stimulus plan announced in March suggests that there will be further investment and, therefore, more government support for the private sector, which, overall, represents a further positive catalyst for spreads over the next few years. Companies on the Old Continent have a less indebted and more resilient profile, adapted to the low levels of growth that have been characteristic of this economic zone for several years.

The situation is different in the United States. Business fundamentals are also good and growth levels favour more widespread use of leverage. On average, companies have more debt, which means they are more sensitive to economic downturns.

An attractive asset class

While tight credit spreads can be explained by sound fundamentals, they are not synonymous with an abandonment of profitability. To put the "raw" observation of the low credit premium into perspective, let's look at the total return on credit bonds today, i.e. including the government yield component. The results are flattering. Over the last 15 years, corporate credit yields have only been higher than current yields a third of the time. For a one-year investment, you need a spread of more than 60 bp on Investment Grade credit premiums before you get a negative return, without taking into account any falls in government yields that could increase the absolute performance of this segment. This last point is now essential, given the great uncertainty about growth, which could force central banks to cut rates further. Against a backdrop of heightened market volatility, bond portfolios, particularly corporate credit portfolios, offer a highly valuable performance cushion.

Source: Mandarine Gestion. (*) Percentile = % of daily observations lower (spread or yield) than the daily observation since 2009.

Does the forecast storm call into question the advantages of European bonds?

In our view, the new tariffs imposed by the Trump administration will have a greater impact on US growth than on European growth. The financial profiles of more heavily indebted companies, combined with lower future growth, will justify revising the default outlook upwards in the coming months. This will lead to a higher risk premium on US credit spreads, which will inevitably spill over into European spreads.

Contrary to what we might have thought at the start of the year, when we were anticipating sluggish growth in Europe and a possible deterioration in corporate fundamentals, the main risk to European credit actually comes from the United States.

But the appeal remains: while money market yields are set to fall further and equity markets, after a very positive start to the year in Europe, have returned to a high level of volatility, bond markets remain highly attractive in terms of risk/return. The lack of equivalent alternatives that has underpinned the asset class for the time being should persist, and flows should be sufficient to absorb new primary issues.

Our preference continues to be for European Investment Grade, with the possibility of diversifying into the highest-rated High Yield issuers.

Barring a very violent recession in the United States towards the end of the year, which for the time being we see only as an alternative risk scenario to the more orderly economic slowdown, we believe that the segment should still deliver a positive performance this year, outperforming money market investments, while keeping volatility below 5% annually.

Completed on 09/04/2025.

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