John Taylor: The consensus view is that the bond market rally is over, but we think things might be a bit different.
The ECB have cut rates from 4% to 2%, and the market is pricing in that they’re now done. Now we have a view that they may need to cut rates one or two times more.
The reasons for that are: inflation continues to undershoot expectations over the medium term; we’ve had wage inflation that has been decelerating quite quickly; as a result of the tariff wars, we have China exporting more to Europe at much cheaper prices; and also, as the market anticipates the Fed cutting interest rates, that should mean an appreciation of the euro as well, further reducing the competitiveness of the exporters.
We do know that we’re getting some support to grow from the German fiscal spend, but even factoring that in, growth is only likely to grow around trend.
Jamie Harding: John, how about expectations for the Bank of England?
JT: They’re much more in line with the Fed, probably four rate cuts over the course of next year. The economy is in a bit of a weak spot. The labor market is weakening. There is scope for gilt yields to move lower there.
How does that macro backdrop lay the groundwork for what the IG [investment-grade] credit markets are going to do next year, Souheir?
Souheir Asba: We still think that the demand for yield will be a good driver for credit returns.
We do acknowledge that spreads are on the tighter end. However, at yields north of 3.1%, there is definitely a good upside from investment-grade credit, from a total return perspective.
We expect that demand to be coming from different parts of the market. So, we expect institutional demand on the insurance side, and anything seven to 10 years and beyond. And then on the shorter end, retail demand should continue to be pretty supportive for European credit.
JT: That yield argument is pretty compelling. But how do the fundamentals look for credit?
SA: The fundamentals are still fairly positive. We do see a healthy backdrop from a leverage perspective. Liquidity for all companies continues to be very solid. That’s true for industrials, utilities. It’s also true for financials. If you look at the capital ratios, they’re still pretty robust and the asset quality is still quite benign.
We are seeing some margin erosions in some sectors, but it’s very localized in some cyclicals, and we do expect that that means more dispersion overall rather than anything negative for overall investment grade.
JT: Sounds promising. Jamie, how does that translate to the high-yield market?
JH: I could echo a lot of points that Souheir raised. We’re in a market where spreads are tight, but yields, from a long-term perspective, are very attractive. At 5%, we believe that we’ll continue to see demand into the market there.
And also, the European high-yield market is a lot shorter in duration now. So, the volatility of return and your breakeven—the amount that yields need to move to wipe out your carry—is high at 200 basis points. So, very positive.
To the fundamental points, broad-based fundamentals are positive. Remember, the European high-yield market is predominantly BB-rated, which is the highest-quality part of high yield. We are seeing dispersion, pockets of volatility within the single-B universe and CCCs. This year has been a bit of an anomaly, where you’ve seen positive returns, but the lower-quality segments have underperformed.
So, active fundamental management will be key going forward into 2026.