We discuss our views on key themes, pressure points in global high yield markets, and the outlook for the rest of the year.
When we think about leveraged finance today, we do believe quite strongly that it is offering very interesting return potential. Currently, yields are such that we expect, in dollar terms, a high single-digit type of return, for the asset class. That comes from a combination of strong carry, which is a combination of base rates and spreads, but also alpha opportunities and total return opportunities from the dispersion that is there within the various sectors and single names within the sector.
“It’s an environment where the combination of higher rate spreads and total return potential is compelling and can lead to very attractive returns on a go-forward basis.”
While we view the underlying fundamentals as strong, it’s important to highlight that the technical picture continues to be supportive. There are a few factors driving this.
Number one, overall corporate mergers and acquisitions (M&A) volumes have been quite low now for a couple of years. The expectation this year was that it would pick up, but due to the macro uncertainty, M&A volumes are still on the lower end. We don’t expect a significant amount of new supply in terms of new M&A to come to the market that’ll lead to high-yield issuance. This is a positive technical for the market.
The second technical aspect is that we are seeing inflows to the asset class continue to pick up. This signals that investors remain attracted to the broader strength of its credit profile. There is a focus on taking high yield credit exposure, especially when rates and spreads are as attractive as they are right now. On top of that, there is a strong return of cash coming back to the asset class from coupons payments. These coupons have gravitated higher, and investors are reinvesting these strong coupon payments back into the asset class.
Technical are supportive, but importantly, what does the fundamental picture look like? From a fundamental perspective, the asset class has continued to improve quite meaningfully. We view the fundamental picture by first reviewing the macro, broader top-down view. One positive component is that household balance sheets are in good shape, globally. Employment levels are stable, with low levels of unemployment. Overall, while consumers have been impacted by higher energy costs and a higher cost of living, the balance sheets of consumers are in a good place.
When we look at the monetary side, the ECB has been on a cutting trajectory now for several quarters, while the FED has been on hold. We do expect a couple of further cuts to come for the rest of the year in Europe, but we think the key message from the monetary side is that ECB is focused on growth.
In our judgement, there are a few key interesting points to highlight for the broad landscape. We continue to expect 2025 defaults in U.S. high yield to be sub 2%. European HY default rates will likely rise to 5-6% when including distressed exchanges and be 1.5% excluding them. In addition, overall leverage levels continue to be stable and reasonable, particularly for European corporates, although, of course, there is dispersion between sectors and between individual issuers. In addition, over time, the rating mix has improved. Finally, there is a quality improvement that’s taking place for the asset class, in part due to lower quality credits moving to the private credit market.
Reviewing spread levels, in the following graph we can see that we’ve had a bit of variability over the last two to three months around the Liberation Day tariff announcements. Our base expectations are for spreads to slowly grind tighter by year-end. We can envisage a scenario where large BB rated fallen angels like Warner Brothers (WBD) and possibly Ford enter HY indices while investor flows remain positive, due to the reduced risk of an imminent recession in the U.S. and lack of a compelling reason to meaningfully extend duration.
As a summary, why high yield now? The key points to highlight are that there is a strong portfolio carry, yield, and total return available, and it comes with strong technical and fundamental supports.
We think while this market environment is challenging, it’s very interesting, from a credit picking perspective. The alpha potential for single names will likely be more meaningful in the next 12 months as the market continues to differentiate issuers based on company results and access to financing.
Credit spread of Global High Yield Index, BB and Single Bs
Source: ICE BofA, Bloomberg, 18 June 2025 Note: ICE BofA Global High Yield Constrained Index, ICE BofA BB Global High Yield Index and ICE BofA Single B Global High Yield Index.