Macro: 2025 will be a new year of divergence
Growth dynamics will remain uneven across regions in 2025. Since COVID, the global macro has been all about the
US. Investors have been laser-focused on the speed of the US recovery, the aggressiveness of its central bank and
the exceptionalism of its tech firms, now coupled with significant improvements in productivity growth. The US
economy is still converging to trend growth from higher levels, while Japan’s growth is bottoming and the UK could
benefit from a fiscally expansive budget. However, China has disappointed market expectations due to depressed
domestic consumption and thus far limited monetary and financial stimulus, with a focus on de-risking and putting
a floor under growth rather than accelerating growth. Meanwhile, the euro area remains the weakest link, althoughe
the slowdown is not broad-based, with southern Europe faring better than Germany and France.
Rates: growing monetary policy divergence between the ECB and Fed will have implications for credit markets
We see monetary policy divergence in 2025 between the Fed (where we expect only a couple of 25bp cuts in 2025
and thus a Fed rate at 4% as the US economy continues to grow at rates above 2% YoY in 2025 and 2026, with
widening deficits and likely stalled disinflation) and the ECB, where the market is already pricing a terminal rate
below 2% by 3Q25. The question is where the ECB’s neutral rate would be, as the GC sees it at a higher level
(around 2.25-2.5%) than the market is currently pricing.
Issuance: supply up in senior & NFC hybrids, flattish (but at a high level) in HY and moderately down in the
EUR subordinated financial space
Credit: still not the time to take a more bearish view on credit markets; we prefer EUR to US credit
Yes, credit is undeniably tight. USD-IG is at the tightest levels since 1998, while EUR-IG and USD-HY are at year-to-
date or multi-year lows. That said, in our view, it is still not the time to take a more bearish view on credit markets.
An environment where growth and inflation are neither too hot nor too cold for a prolonged period, supported by a
healthy dose of central bank easing, does not argue in favour of sharply wider credit spreads – as long as trade
wars do not escalate beyond expectations. We do not see any catalyst that would stop financials from
outperforming non-financials.
Hence, in 2025, we see the high all-in yield argument winning over that of tight spreads, with the
evolution in swap spreads also supportive. On balance, we also see the more attractive valuations for IG in
spread-over-swap terms as a supportive technical; for the subset of investors who view the world through the lens
of spread over swaps, they see valuations as effectively unchanged over the course of 2025.
EUR credit looks like the top pick in 2025 as the ECB walks towards neutral rates, and steeper yield curves support
the appeal of corporate bonds. In the US, we expect the macro picture to remain sound but be less
favourable, and tariff and inflation uncertainty poses downside risks.
In overall terms, which applies to both Europe and the US, we are OW financials vs non-financials and OW non-
cyclicals vs cyclicals. The cyclical risk premium is too low, in our view, as global growth risks are now skewed to
the downside following Trump’s victory, due to the potential for trade restrictions. Non-cyclicals provide safe carry
in our base case of a soft landing and are a cheap hedge against a recession. We prefer subordinated debt (Tier 2,
AT1, hybrids) to HY, as expected supply in the former will moderate in 2025 vs. the record issuance figures we
have seen in 2024.
Risks to our baseline scenario
Most risk factors stem from the US (trade wars, inflation, consumer uncertainty) and have the potential to affect
other markets significantly. The main exception is political risk, with Europe, particularly France, in flux.
The biggest tariff concerns can pose a material headwind to credit markets, particularly when coupled with other
underlying macro worries. For instance, the effect of Chinese trade tensions in 2018-19 was exacerbated by
concerns about growth and Fed policy errors. This is bad news for credit if those doubts materialise and bury the
soft-landing/higher-for-longer narrative on growth/rates that has driven decision-making for months.
In a worst-case scenario, aggressive tariff hikes trigger a tit-for-tat retaliation that hits global trade and increases
uncertainty to the point that global investment collapses, consumer confidence drops, stock prices correct
significantly lower and consumption eventually retraces, leading the US economy into a recession. This scenario
is negative for US growth but even more negative for growth outside the US.
On French sovereign risk, investors appear largely untroubled about the near-term spill-overs to credit markets,
with an acute fiscal crisis unlikely to materialise as a result of the vote of no-confidence. To the extent that the two
most likely outcomes are either a rolling over of the 2024 budget or a new budget passed in consultation with
Marine Le Pen’s National Rally (RN), which incorporates less tightening than proposed in Michel Barnier’s budget
plan, these were viewed as more ‘muddle-on-through’ and would actually be mildly stimulative to the economy.
Lastly, a sudden drop in yields would be a relevant risk factor for credit markets. Our sanguine view on still-
strong demand for 2025 is partly predicated on the assumption that risk-free yields will not drop significantly and
that rate cuts will (over time) unlock more demand. However, if yields were to fall further – with the most likely
driver being disappointing growth rather than much lower inflation – demand could suffer. This is particularly the
case as significant demand stems from retail, and sentiment could be dented by worse growth prospects and
lower yields for taking risk.