The High Yield Outlook for 2025

Will 2025 be another good vintage for high yield bonds? Experts from DNCA Finance, Loomis Sayles, Ostrum AM and Mirova share their views.

DNCA

Following a strong year of performance exceeding 8%¹, the European high-yield² market remains an appealing asset class for 2025 from our perspective, underpinned by resilient fundamentals, robust demand-supply dynamics, and sustainable valuations.

A favourable economic context
In the current environment of sluggish economic growth, corporate investments and M&A activities³ remain subdued, with companies prioritizing deleveraging. Inflation is moderating, and lending conditions are expected to improve as central banks adopt more accommodative policies.

Corporate results in 2024 have demonstrated the resilience of business models, characterized by stable profit margins, effective cost management, and sustained cash generation. Only few sectors, such as chemicals and packaging, have faced significant challenges due to destocking, while the automotive industry continues to contend with cyclical demand pressures and structural shifts toward battery electric vehicles (BEVs).

Default rates have declined and are expected to fall further in the coming quarters. On average, high-yield issuers maintain solid and resilient financial ratios, with further improvements anticipated in 2025.

Valuation and Return Drivers
Although valuations may appear less compelling after significant spread⁴ tightening (approximately 90 basis points year-to-date), current spread levels remain historically sustainable. These levels have been reached multiple times in the past and have persisted for extended periods. The game changer today is that the main driver for credit market is yield more than spread. As we have moved to a higher rate environment, yields are comfortable enough to counterbalance spread volatility and protect carry⁵. The current yield of 5.1%⁶ is still attractive according to our analysis, when interest rates take a downward trend.

Volatility also favours the high-yield market. Over the past three years, European high-yield returns have been less volatile than equities, investment-grade⁷ credit, or even government bonds. The short duration of high-yield bonds further contributes to this moderate volatility, reinforcing the asset class's leading Sharpe ratio⁸ and its strategic importance in asset allocation. However, further significant spread tightening is unlikely, with carry expected to drive 2025 performance.

Supply and Demand Dynamics
In 2025, the high-yield market is expected to continue benefiting from favorable supply and demand dynamics, mirroring the trends observed in 2024. The primary market has been highly active, primarily focused on refinancing, and concerns over a "wall of debt" in 2025 and 2026 have dissipated in favour of a more balanced maturity profile. New issuers such as Zegona or Belron⁹ have entered the market, they experienced rather solid performance as they were offering new opportunities and attractive premium risks for investors from our analysis. Inflows accelerated throughout 2024 as investors were drawn to the asset class's attractive returns and defensive characteristics. This robust demand is expected to continue, providing steady support for the high-yield market and bolstering its returns.

Risks and Uncertainties
While the outlook for the high-yield market remains positive, several risks could impact performance in 2025. The recent election of Donald Trump introduces uncertainties, as his proposed policies on immigration and tariffs could significantly affect inflation and European economic growth. The extent to which these measures are implemented and their ultimate economic impact remain uncertain, as potential knock-on effects on dollar currency, interest rates and U.S. growth could also interfere.

Geopolitical risks also loom, including heightened tensions in the Middle East, Ukraine, and potential developments regarding China's stance on Taiwan. These risks could add volatility to financial markets. Additionally, political challenges within Europe, particularly in France and Germany, may exacerbate market uncertainty.

Interest rates are expected to remain volatile, influenced by U.S. policy decisions that could drive higher inflation and public debt levels. In such a context, Europe’s growth prospects may be insufficient to sustain equity market performance. Against this backdrop, high-yield bonds—with their attractive yields, moderate volatility, and alignment with a slow-growth, declining-rate environment—present a compelling option for investors.

Conclusion
The European high-yield market is well-positioned to act as a "safe haven" in the financial markets in 2025. We expect slow economic growth, moderate inflation, and more accommodative policies from the European Central Bank which is currently priced in. While geopolitical and policy uncertainties could increase volatility, the asset class resilience and attractive yield profile should continue to attract inflows. As spreads are likely to remain stable, high-yield returns are expected to align closely with current yields, offering an estimated range of 4% to 6%.

Ostrum Asset Management

The European market still has potential
At this end of 2024, the European High Yield market is once again outperforming Investment Grade. With ca. +8% year-to-date performance. With an actuarial yield of 5.5%, relatively stable default rates and supportive technical factors, European High Yield should remain the ‘sweet spot’ of the European bond market in 2025.

We think that the European High Yield market should continue to be driven by the trajectory of bond yields in Europe. As money market rates are falling, there could be a crowding-out effect towards the credit asset class, particularly in the European High Yield market. As a corollary, the segments of subordinated debt, in particular AT1 on the financial part as well as hybrid bonds on the corporate part, could benefit from these reallocations.

The credit spreads of the asset class seem rather cheap when compared to the US High Yield market. But they are rather tight compared to their 5-year historical average. Despite a spread tightening in recent months, the yields offered by the asset class remain historically high and should continue to attract inflows (11 months of positive inflows over the last 12 months), supporting the asset class.  Even with a 50 bp spread widening, European high yield performance should be above the Investment grad market. To note that some issuers in the European High Yield market have credit spreads that already reflect very strong economic downgrades, as is the case for the automotive sector for example.

Finally, in a less likely scenario that would see trade war or geopolitical themes improve, high yield risk would be the main beneficiary in the European bond market, and should continue to outperform the bond asset class.

High Yield Issuers: fundamentals resilience
Earnings from European high yield groups have demonstrated resilience, meeting expectations until the second half of the year. However, this period was marked by sudden profit warnings, especially in the auto sector, highlighting a rapid shift in demand dynamics. These downward revisions followed a period of strong results driven by post-pandemic recovery and companies' adeptness at managing rising commodity and energy costs amidst inflation.

Looking forward, declining inflation and easing monetary policies are expected to offer some support for operating performance, even within a challenging economic landscape. Nonetheless, global muted growth prospects and geopolitical risks may hinder significant improvements in performance across sectors. Sectors tied to discretionary spending, facing Chinese competition, and within the European automobile industry are anticipated to be most affected, though their fundamental business models should remain viable.

In recent years, many companies have successfully extended their debt maturity profiles, often securing more favorable terms due to improved financial health including leverage reduction. The number of distressed issuers has decreased throughout 2024, with few below-par debt restructurings. Consequently, default rates for high yield groups are expected to remain well below historical averages in 2025.

Additionally, non-financial disclosures have improved significantly, with private bond issuers in the high yield sector increasingly defining their ESG strategies and setting decarbonization goals, thereby enhancing transparency for investors.

A reality nuanced by segment
This end of 2024 still offers pockets of interesting performance in the European high yield debt market.

While some market indicators have fairly tight valuation levels, they hide in a much more nuanced reality. There is a wide dispersion in terms of valuation within the different segments, whether BBs, B's, AT1 's, or hybrids, which are the core asset classes of European High Yield.

Industrial and/or technological disruption in some sectors has created many investment opportunities.  Exposure to these bonds/sub sectors will drive alpha generation in the coming months.

In parallel, there is a multitude of ‘credit stories,’ at the issuer level that allow, based on rigorous and robust selection, to extract attractive spread levels.

On high beta debt, especially hybrids and AT1's, we are structurally ‘long,’ in a general context of falling rates. We are working on different scenarios to build and manage the allocation. For example, on AT1s, one of the main themes, remains concentration in the European banking sector, and core country risk with its repricing potential.

We anticipate a European High Yield context which should therefore remain positive, supported in particular by strong technical factors. Some issuers offer opportunities that are still attractive in terms of risk/return profile, particularly in the subordinated segment.

Sector selection and stock picking will again be one of the themes for 2025.

Mirova

Never two without three? After two years of remarkable performances (12% in 2023 and 8.65% in 2024*), the European high yield market is expected to once again attract investors seeking yield in 2025, with an anticipated performance ranging between 6% and 7% according to Mirova's forecasts.

This optimism is based on modest but positive economic growth prospects for 2025 in Europe, coupled with now-controlled inflation, which will allow the ECB to continue its policy of normalizing interest rates. In this context, Mirova anticipates a low default rate, while a significant portion of debts maturing in 2025 and 2026 has already been reimbursed.

Moreover, Mirova expects sustained demand for high yield bonds in an environment of historically high yields, thus offering investors attractive carry and a favorable breakeven point. This is further complemented by increasingly significant coupon payments to be reinvested.

At the same time, the volume of high yield bond issuances is expected to remain relatively low, particularly due to increasing competition from private credit. Since the peak reached in 2021, driven by low interest rates and a search for liquidity amid uncertainties from the Covid crisis, issuance volume has significantly decreased. After the pandemic episode, high yield-rated companies have optimized their ratings by reducing their debt and strengthening their credit ratios, notably through asset sales, liquidity injections from sponsors, and reductions in fixed costs and even dividends.

Sector-wise, the automotive industry may hold interesting opportunities. Although electric vehicle sales are slowing and margins are tightening, this sector remains undervalued relative to its BB rating.

Mirova, an affiliate of Natixis IM and an expert in sustainable investment, prioritizes sustainable investment themes within the high yield universe such as clean mobility, recycling and waste management, eco-friendly packaging, efficient construction, as well as health and innovative technologies in communication and security. The subscription economy, particularly resilient, represents a significant portion of the allocation (25 - 30%).

Loomis Sayles

Matt Eagan, CFA, Head of Full Discretion; Loomis Sayles

Are elevated yields and strong credit fundamentals making high yield bonds more attractive? What other factors do fixed income investors need to consider?
High yield bond investors have enjoyed a good run over the past couple of years thanks to attractive all-in yields, tightening spreads, and broadly stable credit fundamentals.  Looking ahead, the category still sports a yield of around 7% while credit fundamentals remain well supported by our outlook for a resilient economy and favorable earnings growth.  On the other hand, the compression in spreads has probably run its course for this cycle.  The spread on the Bloomberg US Corporate High Yield Index has tightened to a current level of +262 bps from a level of +400-500 bps in 2023.  Investors should compare today's level of spreads relative to the potential bite that will inevitably come from credit losses associated with downgrades and defaults.  This difference between spreads and credit losses is known as the risk premium.  Today's risk premium is on the tighter end of its historical range, even considering the generally positive economic backdrop.  The good news is that we believe credit losses will also remain on the lower end of their historical range.  Putting it all together, we think high yield bonds will continue to be an attractive place to get carry, though investors should lower their total return expectations a bit.                  

How do expectations for interest rate cuts and falling inflation play into considerations for high yield investments?
The decline in inflation has been beneficial to high yield investments in two ways.  First, it has reduced the general level of interest rates and, therefore, the cost of borrowing.  Second, lower inflation has enabled the Fed to embark on an easing cycle.  The market and we are hopeful that the Fed will achieve a so-called soft landing.  If the Fed is successful, we are likely to see an extension of the expansionary phase of the credit cycle, which is typically a period high yield provides decent carry with benign credit losses.    

What about growth expectations and potential policy changes, particularly in the US?
Our base case for the US economy is a soft landing in which growth moderates to its longer term trend of roughly 1.75% and inflation continues to bottom to just over 2.00%.  This would provide a decent backdrop for corporate credit health in 2025.  The greatest uncertainty revolves around the incoming Trump administration and which policy changes get implemented.  As we see it, the key risks really boil down to tariffs and the fiscal deficit.  Of these, Trump's tariff policy has the potential to be the most disruptive to credit nearer term, whereas the fiscal deficit is a slower burning risk factor that, if not stemmed, will create longer-term challenges in terms of inflation pressures.  Our view is that Trump's bark is probably worse than his bite when it comes to tariffs.  We believe he will use tariffs as a means of negotiating with key trade partners.  While the rhetoric may be loud, it is important to pay attention to the goal of the negotiations--and damaging the US economy is not the desired end game. Of course the Trump administration has other policies, like deregulation that, if executed well, have the potential to boost the economy and lift corporate profits.  At the moment, the market is giving the new administration the benefit of the doubt.  We will have to see if they live up to expectations.                

How might aggressive US trade policies and tariffs, coupled with geopolitical instabilities, play out for global high yield investments?
We live in a multi-polar world, which is inherently less stable from a geopolitical perspective compared to the period of US hegemony that existed after the fall of the Berlin Wall.  The most important rivalry is between the US and China, but there are other nations that are jockeying for position and exerting some influence on the global stage.  The trend to multi-polarity has ushered in an era in which countries place a higher value on security.  The result has been a reordering of trade flows, trade protectionism, and more hot proxy wars.  This sort of backdrop is not exactly a comforting place for investors, and we should expect these trends continue for the foreseeable future.  Yet, there may be reason to hope for a lessening of tensions in the coming months.  For example, there is reason to believe the conflicts in the Middle East and Ukraine may be closer to some level of resolution or freeze.  There is also the possibility that trade negotiations could head in a positive direction.  China, for example, is battling a weak local economy and is in no position to be looking for a trade war.  Perhaps deals can be cut.  Whatever the case, investors have to accept uncertainty as a reality of a multi-polar world and build that into their investment strategies.