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European credit: Embracing challenges as opportunities
Markets have priced in a lot of good news. Are they right to, or is a more cautious approach warranted?

This article is an extract from our Q1 2025 Active Fixed Income outlook.
The American humourist Mark Twain once wrote, “It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."
Let’s see how this applies to European fixed income assets as we enter a quarter full of uncertain inputs.
The past: what just happened?
Toward the end of 2024, the European Central Bank (ECB) cut interest rates by a quarter point to 3%, its fourth cut since June. The weaker growth outlook and reduced pressure in the labour market enabled the ECB to adopt a more aggressive easing path and the market has priced in further cuts in 2025.
Over the fourth quarter, European investment grade (IG) spreads continued to tighten. When we look at spreads versus government bonds, we think Euro IG bonds still look attractive in comparison to their US or UK peers. In our view, these numbers and the still-attractive all-in yields of over 3%, continue to support the technical picture as we witness strong recurring inflows into the asset class.
The present: Key themes
While we are constructive on Euro investment grade credit, we remain cautious due to the subdued economic outlook, geopolitical uncertainty and the lack of dispersion between higher and lower quality credit which may be a sign of a late credit cycle. While we acknowledge the risk of a further grind tighter as we move deeper into 2025, credit markets are pricing in a lot of good news without worrying too much about more adverse outcomes. We believe a more cautious approach is warranted as we await better opportunities.
In terms of positioning, our portfolios are defensively positioned, favouring higher quality ratings. The spread between higher (single A) and lower (triple B) rated companies has compressed to historically low levels. We also prefer less cyclical sectors and – maybe most importantly - ensure we own credits that our credit analysts believe have sound fundamentals.
What could go wrong?
With the major central banks signalling ‘peak rates’, more rate cuts may arrive as the fabled ‘soft landing’ is at last achieved. This would enable spreads to continue their grind tighter and lower-quality bonds to potentially continue to outperform.
Another risk scenario is a ‘double whammy’ of weaker growth and higher inflation that can pose risks, especially for Europe when a number of factors come into play. This includes the second Trump administration’s policy agenda, supply chain disruption and deglobalisation, while major economies like France and Germany wrestle with weak growth and political risks.
Outlook
Looking ahead, there appears to be a growing divergence between the US, where economic growth remains strong, and Europe, with signs that the weakness in manufacturing is spreading out to the service sector, fuelling concerns about the European economy as a whole. We expect to see more dispersion and differences between sectors and regions.
As we get more clarity around the US policy agenda beyond the immediate market reaction, we think we will be better able to assess the longer-term implications for sectors and companies. These are both challenges and opportunities for us to embrace, and we will continue to balance portfolio risks and seek opportunities through careful selection and diversification[1]
Read our full Q1 2025 Active Fixed Income outlook.
[1] It should be noted that diversification is no guarantee against a loss in a declining market.
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