Credit markets enter their final stretch

In our view, the economic environment and monetary policy decisions on both sides of the Atlantic, combined with companies’ financial strength, have built conducive conditions for investing in the credit market. But how long will these last?

Amid lacklustre growth, inflation is gradually moving closer to central bank targets, allowing the latter to continue their easing cycle. The ECB is expected to be more aggressive than the Fed, which will have to adopt a ‘wait-and-see’ attitude as Donald Trump begins his second term.

The quantitative easing orchestrated in Europe has led to a series of rate cuts that left some investors wanting more. Lowered from 4% in December to 3% in June, interest rates should be nearing 2% by mid-2025. In this environment, yields on money market investments are declining, thereby strengthening the appeal of “carry” strategies for investors.

Meanwhile, default rates have remained historically low at around 2%. In our opinion, a potential and very gradual rise of this default rate would be offset by the low leverage of bond issuers.

Despite geopolitical tensions and the sluggish economy in Europe, we see no signs suggesting that credit risk will deteriorate significantly in the short term. Donald Trump’s return to power could, however, generate more market volatility in 2025.

“Cash is King” but not for much longer

Fuelled by easing short-term rates - positive for fixed income investors - and a recovering term premium, the reallocation of cash instruments held in money market vehicles into the credit market is likely to persist.

After two rather quiet years on the issuance front in 2022 and 2023, the volume of corporate bonds issued in Euros has declined, creating scarcity in the market. Furthermore, due to the abyssal government deficits, corporate credit profiles have become more attractive than sovereign debt, in relative value.

The selection of quality bonds is imperative

We believe that the sluggish growth environment calls for thorough bond picking, with a strong focus on healthy balance sheets and profitability. The ‘crossover’ segment, which includes bonds rated BBB to BB, displays an attractive risk/return combination in our view.

The primary market is proving particularly active, offering a wide range of investment opportunities and attractive premiums, as well as growing alignment with ESG goals. Over the past few weeks, Asmodee - the board game publisher - sparked our interest. Within the automotive sector, an industry currently under pressure, we prefer to invest in sound players such as Renault.

We believe that attractive carry and the monetary easing cycle are the two factors driving the performance of corporate bonds at present. Investors must keep in mind that the window of opportunity for capturing attractive yields in this market may remain open in early 2025, but maybe not for much longer.

Past performance is no guarantee of future performance.

Opinions, estimates or forecasts regarding market trends or changes in the risk profile of issuers are based on current market conditions and are subject to change without notice. Sycomore AM makes no commitment that they will be achieved. We believe the information supplied in this article to be reliable but should not be considered exhaustive. We remind readers that forecasts have their limitations and that as a result, Sycomore AM offers no guarantees that these projections will materialise.

References to specific stocks and their issuers are for illustrative purposes only and should not be construed as recommendations to buy or sell these stocks.