Welcome to No More Risk Better, a Credit Sites Podcast. Across the global strategy team, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets. As the macro makes headlines, we leverage our network of experts across fixed solutions to better understand economic trends, rates, gyrations, geopolitical events, and how these factors impact corporates. At Credit Sites, we understand that credit investing comes down to picking winners to generate alpha and avoiding losers.
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Welcome to our second half of 2025, first half of 2026 preliminary global outlook webinar. My name's Winnie Caesar, and I have the honor of leading the Credit Sites global strategy team today, coming off of a spike in Japanese bond yields and the sort of the US CPI report. We have an action-packed webinar featuring Zach Rivets, US Head of Macro, and IG strategy, Logan Miller, Head of Euro strategy, Regis Chatelier, Head of EM Sovereign strategy, and Zulina Zhang, Head of Asia strategy. What a team.
We have all been hard at work releasing a slew of outlooks for the next 12 months, and our sector analysts in the US, London, and Singapore joined in to provide updated sector snapshots. If you haven't had a chance to check out these reports, they're all up on the Credit Sites strategy landing page. Now, given that we have one hour and five analysts, we'll be going through the highlights of our outlooks. As always, if you have a question, please go ahead and submit it through the Q&A function on the software, and we will do our best to address as many as we can.
We also have the emojis going, which have already been pretty active. Keep them coming, but be kind to the strategy team. We've been working hard the past few weeks to pull together all of these outlooks. With that, as we like to do on the strategy team, we are, of course, going to turn the tables and ask the audience our first question.
And this is, in your opinion, the Fed is A, behind the curve. They need to start easing ASAP, so basically the Trump view. B, well positioned to wait and see, or C, not restrictive enough. Inflation is coming back despite the kind of view that that June CPI report was, not particularly inflationary overall.
Everyone, go ahead and submit your responses. Zach, I'd love to hear from you. What do you think the audience is going to say here? I think it's going to be a mix of well positioned and behind the curve.
I'd love to see some not restrictive enough to get some two-sided risk to the current Fed call, but I'm not expecting that. I think if anything, maybe we get some more behind the curve after this morning's CPI print. All right. Let's go ahead and see what the audience says to say.
Oh, and we have basically almost unanimous expectation that the Fed is well positioned to wait and see. So holding policy rates effectively study is kind of the way to go right now. And then an even split, exactly 8.8% of you think behind the curve and 8.8% is not restrictive enough. Inflation is coming back.
All right. So, Zach, let's start with that outlook for macro and rates in the U.S. as that trajectory of the Fed and the U.S. economy is definitely going to influence the direction of global financial markets.
What is your take on the U.S. CPI print that just hit this morning? How does that number factor into your expectations for Fed policy and rates over the next 12 months? And do we need to totally rewrite our outlook after we just put it out this morning?
Sure, hope not. I don't think I have another outlook in me today, Winnie. I'd say a couple key takeaways from the CPI print first. If you're looking for a huge uptick in inflation in June to be to show the tariff pressure, we saw some signs of that, but not a huge blowout.
So probably a bit of a relief rally there for a risk asset perspective, perhaps from a treasury perspective. I think the curve is actually bare flattening right now. So that's kind of an interesting move in response. And the other thing is, I'd say we had shelter costs come down to 0.2% month over month.
That was actually the slowest pace since February 2021. So definitely more encouraging on the core side of inflation on that very important services part. One thing I note there is it was driven by a big downtake and lodging away from home, which I'd say is growing evidence or part of growing evidence that we are seeing consumer discretionary spending slow down. And I think that's a big key bringing this all back to our overall economic outlook going forward that we think consumer underlying trends are softening.
And that's been a call that we've heard from our consumer team for the better part of the past year. And we think that starts to become more evident in the macro data in the second half of 2025 and in particular in 2026. So when we think about the next six months, really what we've been calling for in 2025 as a whole is the slower potential growth, slower than potential growth environment. That's really what you're seeing from the updated summary of economic projections.
And we think that probably weakens even further in the first half of 2026, driven by a slowing and consumer spending, a softening of the labor market. And we think given some of these underlying consumer dynamics, a relatively modest softening in the labor market could have big consequences for consumer spending. And so with the Fed on hold through the end of this year, we are expecting the Fed to be cutting from more of a behind the curve perspective as we go into the first half of 2026. So that's kind of a big shift in our view, pushing out our views to the next 12 months.
We had been clearly a more hawkish camp expecting the Fed to be on hold in 2025 as a whole, but we are expecting a shift to rate cuts in early 2026. Shift to rate cuts in early 2026. And just to crystallize your view, what is the base case economic outcome first through the end of 2025, and then for the six months of 2026? So it's a continued slowing, I'd say.
And there's a lot of noise in the data. I'd highlight that in CPI as well. I think there was a big inventory build which could delay the pass on of costs. And so we are looking for growth to slow maybe toward the 1% range at the end of this year and perhaps even slower in the first half of 2026, which is where you start to see a softening in the labor market, which ultimately allows the Fed to begin easing.
And so for now, we are concerned about inflation eventually showing signs of the tariff pressure. And I think the other thing that we're expecting is if you don't see too much pressure in terms of consumer prices, you're going to see it in margin compression over the course of this earnings season. So we are looking for that slowing to continue through the first half of 2026. It finally starts to impact the labor market on a more sustained basis.
And that ultimately is what allows or really creates an environment that the Fed has to be cutting into. They're really not cutting proactively, which we think would be our bulk case scenario. I'm sure we'll discuss that in a little bit more detail. This is more of a scrambling to right size where policy needs to be given a weakening economy in the first half of 2026.
Yeah, that mixed between either we're going to see inflation and consumer prices or some sort of margin compression seems a little bit like a lose lose in a lot of ways. Now, Logan, I'd like to follow with you here as the ECB has been a bit more proactive in easing policy than the Fed has. And we've also seen that shift to fiscal stimulus in Europe, and perhaps on last, that's definitely called the relative outperformance of the US economy into question. Though I don't think many people are really expecting that Europe is going to start to really outperform.
How are you thinking about the path to the Euro economy over the next 12 months? And is there a way that the Eurozone could actually outperform the US in terms of economic fundamentals? Yeah, I think 20, great to be here. So, look, I think over the next 12 months, the focus is going to remain on how Europe responds to US trade pressure, how companies manage their higher tariffs in both in terms of their investment spending plans and navigating growth challenges.
And then lastly, how quickly and effectively these fiscal spending plans will actually boost the industrial economy in Europe that's faced several years now of headwinds and underinvestment. But I think most importantly for our outlook is really the direction of travel. Right now, if you look at a range of metrics, whether it's pronounced year to date strength in the Euro currency, seeping of European sovereign yield curves, or credit spread near their tight over the past decade, there's certainly quite a high degree of optimism that's being priced into European markets. And on the data front, a number of soft and hard data indicators have confirmed much of the optimism, such as the bottoming out of industrial production recent months.
We've seen stronger PMI figures and even Germany's economic sentiment survey that was released today came in much greater and much higher than expected. So, I think to some degree, I think the relative positive sentiment is a reflection of uncertainty about many of the things that Zach touched on regarding the US outlook, which has caused a rethink among European and foreign investors about their exposures to the US. This seems to be indirectly and somewhat counterintuitively benefiting demand for European credit. We just have to look at fund flows, retail fund flows, which have shown very strong inflows to Euro credit, notably out-pacing that of US credit as we point out in our monthly credit compass report.
So, we need to answer your second question whether or not Europe can really outperform the US. I think there's certainly a number of supportive factors for European fundamentals, many of which have just emerged over the last six months or so. But that being said, from evaluation standpoint, which we would argue is the biggest challenge for investors at present, it's going to take more than the perception that Europe can sustain a slowdown on the other side of the pond based on positive domestic trends really to justify currently tightly wound spread levels. So, I would argue that Europe cannot grow it alone.
I think potential weakening of the US and or a trade slowdown with the US which translates to weaker domestic demand. And Europe, particularly considering that the export nature of many countries and sectors, which I don't think is being priced into European risk assets right now. Hence, we remain pretty cautious on the direction of Euro-IG and Hyelts spread over the next 12 months. But perhaps based on our updated forecasts, which we'll get into in more detail, we do think that Euro-Spress can still continue to trade inside of US-IG credit or instead otherwise widen less over the longer term.
Just given that the more proactive ECB over the past year and those positive technicals that we describe in today's outlook that we published. Yeah, it's so interesting to see how the start of the year was defined by American exceptionalism and expectation for continued outperformance by US asset classes. And that inflow into European asset classes this year has been quite tremendous. Another area where we've seen some pretty solid demand, especially for those yield buyers, is in the world of emerging markets.
And Regis, you have the pretty much impossible task of identifying the potential impact of US policy on a wide range of EM sovereigns in your coverage. Many of those have a complicated relationship with the US. Now, I realize that the outlook for EM fundamentals is really mixed. It depends on the region or even the country.
But what are some of the key trends that investors should be monitoring over the next 12 months from a fundamental macroeconomic perspective for EM sovereigns? Yes, indeed. The situation has been quite diverse, depending on the region and even depending on countries. But overall, EM economies have been quite resilient, growth averaging something like 3.6% in the first quarter.
That is, ex-China. And these performances basically in the 2004s, we haven't seen meaningful slowdown at an aggregate level at least so far. Southeast Asia still continue to grow pretty at sustained pace. Around 5%.
Also momentum has been also improving in Latin. Countries like Argentina, Chile, Peru have been doing quite a quite okay with the pick up in the Middle East. North Africa is doing quite a okay. Saudi Arabia is picked up on growth production, on oil production.
But even beyond that, you have Egypt, Morocco, pretty strong growth. The region that is slowing down clearly is CE countries with the economic slowdown in Western Europe affecting the region and with particular emphasis on the auto sector that is weighing on exports for the region. Now, it is difficult to predict the impact of US tariffs at this point for EM. But the main issue, I mean, precisely with the main issue, has been the predictability of US trade policy and the stability of global trade framework.
However, I would expect EM GDP growth to be too slow down a bit, probably around 3.5% this year until early 2026 from to 3.8% in 24. So we're going to have a meaningful impact eventually. Now, what are the trends to monitor going forward? Because again, there's a lot of uncertainty around that.
First of all, the actual implementation of US tariffs, some countries, having these complicated relations with the US, we've seen some tariffs increases that were decided solely based on political ground. For example, Brazil that was hit by 50% tariffs was Donald Trump trying to put pressure on Brazilian authorities to drop the case against expresence Bolsonaro or South Africa. For example, it's targeted by 30% tariffs. Don't Trump considers that South African white community has been discriminated by the South African government.
So beyond economic rationale, you have some political objectives. I tend to think personally that the tariffs that are based on political ground are going to remain higher than those that are based purely on the relative size of US trade deficit. The second trend to monitor is the impact on tariffs on inflation, who's a global inflation and global funding costs. If the Fed does not cut interest soon enough, it's going to be difficult for emerging markets to ease monetary policy.
Even though EM real policy rates are still quite high by historical standards, another impact to or another factor to monitor the momentum of GDP growth and exports. I think it's pretty self-explanatory. But I would say the main one and probably not the one that we don't emphasize enough is probably fiscal deficit and debt supply. Fiscal deficit is really quite high in EM and even more so in developed markets.
But if you look at EM, EM has an average deficit of 4.4% of GDP and that is excluding China. And bond supplies have been increasing quite a lot in the past few weeks. So these are risks we need to monitor going forward with the caveat that we still have quite a lot of unknown as well as US policies concerned. Unknown as far as US policy is concerned, and I think that is a great segue into you as it seems that trade agreements and relationships with the US and Asia are definitely continuing to evolve.
Oftentimes in ways that are surprising to me, especially with Trump's letters last week to Japan, Korea, and Vietnam, is Asia positioned to withstand the tariffs that are currently in place or expected to go into place on August 1? And how do you feel about the fundamental trajectory for different countries in the region? You know, I think tariffs if implemented in full scale will likely hit export reliance Asian economies, particularly Japan, South Korea, Taiwan, Thailand, Malaysia, Singapore, Vietnam, and China. But so far, we are not seeing this showing up in the export data likely because of the front-loaded activity of exports.
A few markets do carry some pockets of resilience and they have trade deficit with the US, like Australia, are very much domestic activity driven like Philippines, Indonesia, and India. In general, Asian investors are expecting trade negotiations with the US to bring down tariff rates, particularly in Japan, South Korea, Thailand, Indonesia, where the negotiation has been ongoing with the US. And even in China, the tone looks quite positive with an initial framework, and now the US is loosening some of the chip on the exports to China, so it looks like some positive direction to go. There is in general market hope for sector level concessions and exceptions in autos, metals, and semiconductors.
And the other thing is the strength of Asia effects against the broader US de-wigness and overall very well-controlled inflation are enabling Asian Central Bank to maintain dollar-ish policy stance. A lot of them are going to cut over the next 6 to 12 months to support growth, so this resulted in very strong local funding conditions and the capiation high-yield default rate. Asian governments are also proactively rolling out a lot of fiscal stimulus to mitigate this external uncertainties, particularly in China. There has been a lot of infrastructure, property consumption, and related stimulus into different sectors.
South Korea, under the new government, is also rolling out more stimulus measures. Japan has the SME support program as well as the auto support program. That said, we are a bit concerned about the macro outlook of Thailand because of political instability that might delay some of the fiscal stimulus rollout and Indonesia because of the decentralized policymaking and the loss of consumer confidence as well as the confidence of some of the offshore foreign investors. Great.
And Zalina, I think that a topic that came up a lot in April, but seems to have died down a little bit, is the rotation away from US. And that was especially true when we were talking about Asian clients. Now, how are clients in Asia thinking about the outlook for the US? And more importantly, has that much discussed by your strike of USC assets actually materialized in a meaningful way?
I think there is very limited conviction among Asian investors about the direction of US macro. I think investors here are just as data dependent as the fact. But most Asian investors have a quite positive outlook, I would say it's like Goldilocks, they are always benign inflation, still supported labor markets, and slightly below trend growth. I think this gives Asian investors a lot of reason to chase USD assets, at least we now, even the depths and the rest of the market.
There is still some concern about the medium to long-term perspective, a prospect of USD since April, but overall, we are not seeing any big real money clients dumping USD assets, including the fixed income asset classes. And more and more Asian credit investors, they are indeed buying into some of the cross-currency positions, especially in Asian local currencies. Australian dollar is one popular asset class, given the Stikov, goods red pickup, and also the very strong Australian dollar. Euro is one very on-topic all asset to buying two for Asian investors, because of the outperformance versus US IG, high yield and also the very strong euro.
And in particular, some of the new euro bonds issued by Asian investors are surprised at very, no very stretch levels. We do also see some increased interest of Asian credit investors buying US asset assets, US IG, and expanding into the high yield a leverage loan space to chase the spread. The context is that Asian spread is actually tighter than US spread in the IG space, so this gives Asian investors still a lot of reason to be positioned in US treasury. And one last interesting observation is a lot of Asian clients, especially in Hong Kong and Singapore, are using leveraged positions to go along in US treasury, because of the collapse of high-born and slora of the past two months.
We are seeing very aggressive by 10 times leverage buying 30 US treasury. Yikes, 10 times leverage buying 30 US treasury. Feels like that could go a bit sideways. So let's get to our next audience polling question, which is markets have posted a tremendous recovery since the depths of Liberation Day over the next 12 months, which do you think will be a more important driver of sentiment and valuations?
Is it a strong technicals and cash on the sidelines, which I think a lot of people have attributed the most recent rally to be improving fundamentals or see the more negative fundamental outlook weakening fundamentals, rising downgrades and defaults? This is a topic that Zach and I spend a lot of time debating, that technical versus fundamental as so much of our view in the Fed rate hiking cycle, which began in 2022 and our expectation that we were not going to see a recession was predicated on all that ample liquidity that had been injected into the system from both EC monetary policy and a lot of fiscal stimulus. Now, the big question is, how much of that cash is still on the sidelines? And is there a point where fundamentals get weak enough that people don't care about the cash?
They just want to stay all cashed up. All right, let's see what the answer to this question is for our audience. And we have a more bearish audience. This comes as a little bit of a surprise to me.
Maybe everybody has read our outlook and they are fully convinced. We getting fundamentals, rising downgrades and defaults get almost half of the votes, whereas strong technicals cash on the sidelines is the second most popular answer. And then 20% of you bullish optimists, do we have equity investors on the call? What is this improving fundamentals?
All right, Zach, I'd like to circle back to you. Oh, actually, we have another audience question. Sorry about that. And then this is which US as a class to expect to generate the strongest total return performance over the next 12 months.
We've got cash, we've got long-dated US treasuries, we've got US investment grade, US high yield, US broadly syndicated loans, or I'm a crypto bro. We're just going to buy all the Bitcoin, the Dogecoin, the Ethereum, all of those crypto things that I don't really do much in. While people are responding to this, is there any other question from the audience about can you identify factors behind Asian demand for USD, credit, and treasuries? Can you just speak to a little bit more about those demand drivers around Asian investors?
Yeah, I think a few factors. The first is about the relative value because right now, Asia, Asia, is trading 10, 15 basis points, tighter than USIG and historically, it's about 20 basis point, wider. So relative value is really much better for a lot of Asian investors in USIG. And they love investing in the big names that they are well known to the Asian credit investors.
Second bit reason is the size of the Asian US dollar market is shrinking because of the continued and active new supply of the past two and two to two half years. And a lot of investors are trying to diversify outside their pure Asian mandate other than USIG, EuroIG, as well as Australian, Japanese, and shows even like Middle East banks, these are older areas that Asian investors are looking to expand into. The third reason is just we have a lot of regional accounts investing in the USDS class compared with the onshore rates in markets like Korea and Taiwan and China. US yields are just way too attractive even despite the very stretched threat.
I think quite different from North America and European markets. Here we have a lot of oil buyers. So even the spread level is tight, people are not looking at that. And they're actually focused on carry to return and oil yields.
Yeah, that makes a ton of sense. Thank you so much, as early as that. All right, so getting back to this audience polling question, we have kind of a mix of expectations here. Now, I would like to shout out the 20% of the audience who are crypto bros.
Good luck with that. We do have the topic is US high yield. Now, this surprises me a little bit given that fundamental erosion was also kind of the consensus expectation for driving valuations over the next 12 months. Second to that is US investment grade, which I think does actually present kind of a compelling all in yield buying dynamic.
Zach will get into that a little bit more. And then we have long-gated US Treasuries, broadly syndicated loans kind of at the bottom of the stack and no love for cash, only 5% of the audience. So Zach, let's circle back to you. Let's discuss some of the macro wrecks in your most recent views on US IG corporate credit.
Are you thinking about our base case for the next 12 months? Where do you see the most value in the US Treasury market? Should we be loading up the duration boat around current levels? Thanks, well, yeah, just to start with the Treasury picture, I know I didn't head on that earlier.
We had a slide looking at our calls relative to the Bloomberg consensus and forwards. And I'd say we have a more nuanced call over the next 12 months. It's really a tale of two six-month periods where we are maintaining our 4.75% tenure treasure yield forecast for year-end 25. And I think the way we are positioning that to clients is highlighting the risk that yields can move higher from current levels, particularly at the long end of the curve between now and the end of the year versus really a point estimate for year-end.
And the way we're thinking about that is they're going to be better entry points to add duration, at least at the tenure point, at some stage over the next six months. Now, with our expectation for growth slowing, the Fed to begin easing and the really economic picture, I'd say the fundamental picture to start showing clearer signs of weakness, a shift in this pretty exuberant risk on environment we find ourselves in today. That pushes the 10-year yield to 3.5% in our base case in the middle of 2026. So a big move lower, that's quite a bit lower than consensus, way lower than forwards.
And I'd say the way that we're looking at that is our weakening growth scenario drives a somewhat lower yield environment, just a little bit flattering curve when the market is priced for. And so putting all that into our IG view, we do remain underweight US investment grade, our spread target for the end of the first half of 2026 is 130 basis points on IG. And the way we're really thinking about that is just a return to median, a pricing back end of credit risk into the system. And we think some of the liquidity in the system is going to shift from feeling so abundant as when he alluded to to sort of shifting those dynamics as treasury builds its cash balance and the Fed continues its quantitative tightening.
And so the way we want to position in US investment grade credit today, we like remaining up in quality, we think single A's both in corporate and financials are sort of the sweet spot. And we'd prefer at least the near term to remain up in our shorter end duration, I should say, and we're going to be looking for better opportunities to extend duration, particularly for total return focused investors. If you are in that access return cohort, we aren't looking to add spread duration, obviously at these levels as valuations are rich and we are looking for spread widening. So it's a nuance to view from a few different perspectives, but we are expecting yields to kind of stay in this range and perhaps move higher through year and offering better entry points.
Our call is for spreads to widen as credit risk is priced back into the system and some liquidity that we felt so far this year starts to fade. And that's how we are thinking about the market today. We'll see if that changes over the next day or the next week, but that's how we're taking all the inputs and factoring them into our position and recommendations. Great.
Thanks, Zach. Kind of a follow up to that. How long on the US Treasury career would you go? Sanir Max, given dismal fiscal picture, et cetera.
Or are we going to just buy up all those 100 year zero coupon treasury bonds that are coming our way? That's a great question. One of the ways we've been looking at it is real yield. If you look at the 30 year real yield, it's 2.65%.
And while we are concerned about deficits and what it means for the longer term fiscal picture in the US, if you look at economics slowdowns and we're not calling for recession, but economic downturns, that ultimately is the bigger driver and you see yields fall and really the curve will steepen. So I'd say in general, we are more comfortable moving out the curve. If we see yields move to maybe say 5%, I think that's just a touch higher or we are there today. I'm a 30 year looking at it from that real yield perspective.
So I'd say in general, we are comfortable moving out the curve as we think focus will ultimately shift from deficits to a slowing growth picture and a fan easing in the first half of 2026. Great. Thank you, Zach. So on the US leverage, hindsight of things for us, high yield technicals have perhaps been even stronger than in the US IG market with robust inflows after that liberation day risk off move and pretty limited new issues supply, especially on a net basis.
Now, despite most of the sell side desks expecting a dramatic pickup in primary market activity this year, we still have prohibitively high borrowing costs keeping a bit of a lid on M&A and refinancing activity, especially for lower rated issuers. Now, we are not going to argue with the recent strengths in technicals and indeed cash on the sidelines did underpin some constructive calls on US credit in recent years. That being said, we worry now that the credit fundamental picture leaves high yield more susceptible to shifting risk sentiment, particularly if recession fears again rise. The recent upgrade cycle is starting to lose some steam with cyclical sectors like home builders and airlines facing more headwinds in recent months.
Even consumer goods in the high yield market has a higher alignment to discretionary categories, while the Uber tariff exposed auto sector is already trading at very tight levels in the high yield market, given mostly auto suppliers there. Now, overall, we do find it a bit difficult to justify spreads below 300 basis points, even if yields are still around 7%, as we expect that downgrades and defaults will begin to edge up again over the next 12 months. Our official high yield default forecast for the year long period ending June 30th is 3.5% to 4%. So that would mark a modest step up in defaults still historically rather low, but definitely higher than it has been for the past year or so.
Now with this in mind, we have an up and quality strategy in the high yield market. We don't mind taking some duration risk in double B rated issuers to capture some yield and spread there. Valuations are really bifurcated in high yield. It makes it very difficult to construct a 7% portfolio without taking at least some triple C risk or reaching into sectors that have been a little bit more beaten up as of late like telecom.
Indeed, that sector is our sole overweight recommendation as we see the shifting pollocks e-mix as a more positive catalyst while event risk and access to liquidity in the ABS market provides some additional support to the telecom sector. Now, within the broadly syndicated loan space, our call for a faster than anticipated decline in base rates and preference for duration over credit risk cleaves our appetite for low and risk rather low. Loans have already lagged high yield this year despite high base rates as prices are already quite high for double B and single B rated tranches, and that leaves limited incremental price appreciation. While the loan market effectively cleared out a lot of its liquidity and refi risk in last year's issuance, Bonanza, other positive event catalysts like a rapid rise in LBO activity or sponsor to sponsor M&A has really yet to materialize and that has resulted in a higher prevalence of dividend recaps yields in the markets.
For the BSL market, we see the lowest potential for total returns in both our base case and on a probability weighted basis. So as we're thinking about recommendations for yield-based buyers, I would say that we prefer US investment grade first, high yield seconds, and leverage loans third with an underweight allocation to credit risk wholesale and a view that access returns are probably going to come under some pressure over the next 12 months or so. Now, Isarlina, I'd like to get back to you as I've been pretty shocked by the resilience of the Asia market. You did outline a lot of the technical factors that have been supporting it.
Asia IG spreads very tight to US IG. Asia high yield back at the low 300 basis point area. What has driven this incredible compression and spreads? And where can investors still find some value in these markets?
Yeah, we're also quite shocked. And this is the second year of both 2024 and year today, 25. Asia IG and high yield beat US and EuroPEO appears in total return year to date just like in the US. And markets that are in the crosshairs of US tariff like greater China, Korea, Japan delivered the best performance like very surprisingly.
I think a lot of this trends is attributable to the B9 macro backdrop. We are not seeing this tariff risk flowing through into hard data. And again, the strong technicals, it's not just about the new supply, but also the very strong regional inflows from different yield buyers, Chinese accounts, Korean accounts, whales accounts in Southeast Asia, and nowadays even some of the middle East related whales accounts. And the Asia high yield default rate has been normalizing with the very good onshore founding conditions, and the China high yield property default is already behind us.
So overall, I think we still have some of this preference over the for duration risk over credit risk. This has been the case since April, this year, given the spike in yield, but the spreads has been very stretched. And we think if there is a potential retreat of risk sentiment and because of the US macro situation, then Asia spreads are very vulnerable to any very significant widening. And here we are talking about idea of diversification.
We are seeing this as the best protection for Asian credit portfolio. So for duration plays, we are talking about diversification across the Japanese life earth, updad greater China attack property. Some of the Southeast Asian quasi with very steep curve, but honestly, in Asian credits, the long anti-juration supply is limited. And also the curve is not as steep as US IG credits.
And for credit risk, we are doing a barbell strategy. So we both position in quite defensive names, like China IG, some of the Hong Kong aerated names, but we also do some beta though we are quite selective in terms of both IG beta and high yield credits in Asia. Excellent. Thank you, Isarlina.
So reach us back to you on the EM Sovereign Market. They fared pretty well this year, though EM IG Sovereign spreads are still the widest of the markets that our strategy team tracks. Do you think that the strong performance so far is set to continue and how do you recommend investors allocate portfolios in EM Sovereign? Yeah, I would like to start with one remark.
Indeed, Sovereign IT bonds trade water than US corporate IGs, but still trade pretty tight. They have outperformed thanks to longer average duration. So if you look at Sovereign IGs, they have an average duration of 7.8 or so, which is about one year longer than US corporate IG. So that obviously helps as you had US Treasuries tightening.
But yes, overall EM performance has been quite decent, including for solving high yields by 5.3% of the day. It's a bit higher than solving IG. So a pretty decent performance. That being said, violations are very tight.
We are done with it. EM serving IGs to underweight. Spread variations are within the 1% most expensive since 2013. And we remain even more cautious on EM high yields simply because spreads are very tight and more vulnerable to global repricing and unreasonably tight.
We would expect spread differential between serving high yields and serving IGs to 1.4-100 basis points or so from 270 basis points currently, which is very tight by historical standards. As far as allocation is concerned, we are pretty defensive position on across EM. If I take the best pick, I would say, Stadio Arabia, we have performed on Stadio Arabia, which is a critical strength and demonstrated by the recent upgrades from goodies and S&P. Growth prospects are improved.
They are increasing production. That's going to help GDP. Obviously, but beyond that, there was some concern before on risk for fiscal slippage. I think this risk is quite contained and that levels are pretty low anyway and effective is a huge.
I think risk reward and Stadio Arabia is pretty good at attractive, especially if we consider that we could have a global repricing. I'm more high yield spectrum. I'm quite defensive. Morocco is a bit of a frontier market, but I think it's going to outperform.
I think down the road, it could be even upgraded. You have pretty strong FDI and pretty strong tourism industry. Public debt level is quite high, but fiscal outlook and fiscal trend is positive. Also, risk reward is attractive.
Again, this is a pretty defensive position relative to the rest of high yield. For the big names and the IG names, I would certainly avoid Mexico right now. I don't think all the risk are priced in. Of course, there is a US tariff story, but beyond that, there is the risk on Pemex, the state oil company that is increasingly weighing on the budget with increasing financial support from the government.
I would expect that we'll continue and I'm not sure that everything is priced in at this point, knowing that Mexico tends to be a bit of a high detail within the IG space. I would expect it to end up a form. Lastly, on the underperformed side, Egypt has been quite well in terms of economic recovery. The inflation is down.
It's been a bit of a bit of a downing recently with a lot of investment from GCC countries, but the fiscal situation is quite alarming to be honest. We could expect something like a deficit of 12% of GDP, one of the highest in the world. We still have some disruption to the Sres Canal because of terrorist attack and that has negative impact on public finances. Beyond that, in the very high yield spectrum, valuations are very tight.
I guess if there is a repricing, the names like Egypt or Nigeria could easily widen and perform as we have a global repricing. That's it for the allocation. Thank you, Regis. Logan, let's go to the European and Sterling credit markets.
Euro, especially as you noted, has really benefited from that range of technical and fundamental factors. It may be part first option, but part reality. You have been a little bit more constructive on Euro high yield. That trade has worked out pretty nicely.
Now, how are you thinking about allocations to Euro-IG and high yield over the next four months? Yeah, look, we maintained our underweight recommendation to Euro-IG going into the second half based on the basis that evaluations are surprising and too much optimism around fiscal spending, especially in the very near term, as well as the newfound European exceptionalism theme that's emerged this year. Also, not reflecting the reality that tariffs are negative for fundamentals and growth, even if it's a bit more nuanced than we thought it would be back in early April. I think it remains to be seen how effectively and quickly fiscal spending translates to positive momentum in the private sector.
That being said, in terms of our recommendation, it's not to be outright short or sell IG credit as we realize balance sheets are in a reasonably good starting place. There are also fewer alternatives outside of credit in Europe that offer compelling yield. I think that's certainly a key technical driver for demand that we've seen. To that point, the ECB has been considerably more dumish than other central banks, which I think is certainly helping demand for Euro-IG credit from a non-Euro perspective.
We are forecasting a slower grind wider compared to our original year-end 2025 forecast, which we have taken down to 100 dips for Euro-IG in our updated base case scenario. Instead, it comes down to, as I think we expect and we recommend investors take a more tactical approach to allocating to Euro-IG via sector strategy and credit selection. We've been recommending to take advantage of pockets of strength like we've seen in recent weeks to move up in quality in the companies that have defensive balance sheets and sectors that the market that look compelling on a long-term basis. We publish a monthly Euro-IG sector strategy rail down monitor each month.
I'd highly recommend taking a look at that for some opportunities and also some chart on our outlet today. But over the longer term, I do think we are expecting spreads to widen back towards the longer-term average in the first half of 2026. So, kind of a continued widening over the next 12 months. We're forecasting ID spread in the first half of next year at 120 basis points.
I would note, however, that this is slightly below our more bearish view coming into the year. For Euro-high yield, we're thinking with our call to be market weight for the second half of 2025. We continue to view all in yields as compelling for dedicated high-yield investors. And as I mentioned, as you've had lower yields, an idea does also create an impetus for some of the some-ID investors to dip down into into double-b's.
Fundamentals, particularly for double-b's, are about as strong as they've been in recent years. Most companies have already addressed near-termaturities. Leverage remains intact at multi-year lows while interest costs are becoming less burdensome compared to recent years. So, we're expecting to see spread-winding alongside IG over the course of the next year off of extremely tight levels.
But total returns should outperform Euro-IG at around 2.5% on a forward 12-month basis, or even higher based on our probability-weighted forecast of around 4%. We also expect high-yield bond defaults to remain somewhat steady, but well below peak levels in a range of 2.5% to 3% by the middle of next year, which I think is already being reflected in market-employed stress ratios at the low end of the range spectrum. So in short, we think strong technicals that we've seen in recent years can remain intact as long as the growth picture continues to hold up, which we are expecting it to do. Great.
And then Logan, do you have any quick thoughts on the sterling market I realized? It's a little bit smaller, but still one that people ask about regularly. It is. Yeah, sure.
So, look, I think the technicals for sterling IG have been underpinned by pretty limited new issue supply, as well as UK liability-driven investors walking in pretty compelling book yields, which is a reflection, I think, of elevated financing costs, as well as just a lack of new money borrowing in recent years. But from a valuation standpoint, and credit specifically, sterling IG is basically at the tightest level since before the great financial crisis. I think given our concerns that we've written about our alic around spread duration, I think sterling IG is far more sensitive even to incremental losing spread. So we're forecasting for actors return to notably underperform over the next 12 months.
I also think in many ways, the Bank of England is in a very tough spot. Inflation pressures have certainly seemed to resurface in recent months, while growth has also been quite tepid at best. So we think that the Bank of England should be cutting rates. Our concern is similar to your views on the Fed that policy may already be behind the curve.
The UK is also dealing with a fragile fiscal situation around the budget and deficit spending, which is left guilt is quite vulnerable to a number of sell-offs already this year. So with those factors in mind, we think the risk for work proposition is skewed to the downside. So we're sticking with an underway call on sterling IG. Excellent.
Thank you so much, Logan. So, we're going to get to our next audience polling question, which is a kind of segue from what we were just talking about with our cross asset recommendations. So outside the US, what is your preferred market for total return performance over the next 12 months? Do you like Euro IG, Euro high yield, EM sovereign IG, EM sovereign high yield, Asia dollar IG with those very tight spreads, or Asia dollar high yield, you can go ahead and vote now.
There is a question from the audience is that I'm going to have you answer while people are voting. If we have this weakening growth scenario, but there's currently a pretty large and getting larger fiscal deficit in the US, what do you see as the impact on the sofor swap basis? Yeah, it's an interesting one. I feel like this has been a hot topic with the changes in SLR regulation arguing for wider swap spreads or less negative swap spreads.
The big thing I think that we've seen happen is treasuries have cheapened versus swaps as there has been so much issuance. And one of our big concerns coming into this year was more issuance for the curve as deficits remain large and potentially widen going forward. What we hear from Treasury Secretary Bessent is they are not looking to term out that and given the passage of the Genius Act, we think they're going to rely more heavily on the front end of the curve for a sustained basis. And so in general, we're not looking for swap spreads to become even more negative in terms of treasuries, cheapening more because we're not looking for that supply to be termed out as much.
And so if you're thinking about 10-year swap spreads around 50-55 basis points, I don't think that gets a lot more negative from there moving further out the curve, something in the 85-90 basis points range for 30-year. We're not looking for that to worsen. So that's been kind of a big shift. And also adds to why we are a little more comfortable with yields moving lower across the curve in the first half of 2026.
Great. Thank you Zach. Great. Let's see what the audience has to say about their preferred non-US asset class.
All right. We have some Euro bulls in the house between Euro IG and Euro high yield. We have about 58% of votes, less love for Yam Sovereigns, and then very little bullishness on those eight tight Asia spreads both in the IG and high yield markets. All right.
Last audience question that we're going to ask today. What do you think is the biggest risk facing markets in the next 12 months? Is it a re-acceleration in global inflation, a demand drop off or slowdown, liquidity stress from restricted monetary policy, geopolitical escalations, or something else? You can drop it in that Q&A box and let us know.
You can go ahead and vote now. And while everyone is voting, Logan, I'm going to ask you an audience question, which is why would US growth slowdown be a drag on Europe? We are curious if you can dive a bit deeper into that. Yeah.
I think there's probably a couple things there, but clearly the US is very interconnected with Europe. Number one, the US is the largest buyer of European goods. So if you're a flargest exporter, this has actually increased pretty substantially in recent years. So I think it's slowed down in demand from the US.
We would certainly put renewed pressure on the ability for Europe to expand, given the trades that I mentioned. The second thing is that there's a large share, I think more than 50% or so of European revenues, at least if you're looking at companies in the stock of 100, generate revenues outside of Europe. So clearly, I think a meaningful slowdown in the largest economy in the world, that is the US coupled with Euro strength, puts downward pressure on earnings growth, which I think we actually might start to see some of that come through in second quarter earnings. And then the last thing I'd probably mention is, slowdown in the US and sort of weakness in the dollar makes it much more expensive for US investors to spend their holidays in Europe, which certainly has helped boy out growth, especially in destination countries in recent years.
So those are probably three things that come to mind. Great. Thank you, Logan. All right.
So biggest risk facing markets, people are a little bit mixed undecided. I'm surprised that geopolitical expectations comes out at the top by just a small margin as the markets have really shrugged off any sort of geopolitical risk for quite some time at this point. Re-acceleration and global inflation is number two, but very closely followed by number three at demand at slowdown slash drop off, liquidity stress from restricted monetary policy. No one or very few people really expect that.
All right. So let's do a speed round and I'm going to have everyone tell us, you know, what is your top risk that you think is underappreciated or what's the most country in view that you have for the next 12 months? And Zach, let's take it off with you. Wait, this is a perfect lead-in because mine is liquidity will start to dry up in the second half of this year as you have treasury rebuild its cash balance, a couple hundred billion, what's a couple hundred billion amongst friends.
And even though the Fed has been doing QT for three years now, bank reserves in the system are actually up 0.8% as that's all been absorbed by the overnight reverse repoverstivity so far. So we are expecting reserves to fall in the second half of this year and going forward. And I think even though liquidity seems ample now, I think that rate of change versus the actual level becomes more of a driver of markets in the second half of this year. I think that's an underappreciated risk.
A little bit of liquidity stress coming our way. Logan, how about you underappreciated risk or country in view? Yeah, I think the top risk to our outlook is that compressed or even tighter spreads remains the pain trader in the next 12 months. You know, I would argue that based on asset price growth relative to the economic growth, perhaps the ECB has loosened policy too much, especially considering that financial conditions are now much more accommodative in Europe compared to the rest of the world.
I think that means that investors are having to take on more credit risk to achieve a reasonable level of reinvestment yield. It also means that companies are being incentivized to pursue more aggressive financial policies, potentially at the expense of creditors and for death, particularly if real investment spending due to tariffs remains quite low. So we've seen minimal M&A issuance over the past few years, but now that the cost of debt is for larger acquisitions and inorganic shareholders returns is much more affordable. We could see re-leverging activity surprise to the upside over the next 12 months.
So while we're at a positive theme for European equities, I think it would be more negative for IG than in high yield. So I suppose that supports our underweight recognition to IG versus our market weight allocation to high yield. Back to the world of intentional re-leverging. Okay, Regis, how about you, Key risk or country in view?
I mean, I guess the main risk is still, but on the on-trap keeps postponing the actual implementation of tariffs and that case the market will become even more complacent. And investors continue to buy on EMS ads purely based on relative carry, but of course, ultimately, these tariffs could be implemented and likely to be implemented somehow and much higher than before. And this is where, you know, re-pricing becomes aggressive. But in the middle of the meantime, in this scenario, it could be quite smooth.
But the top risk that the market is probably underappreciating is probably the fiscal risk with heavy debt supply starting to affect risk appetite ultimately. So that's basically concerned. It's been very much under the radar so far, I guess, the standard of US as a new standard in this respect, but still, it's a risk. Great.
Thank you, Regis. And then really, I'll go to you next. Yeah, I'm trying to debate between the two. The first one is one supporting factor for Asian credits in the past two years has been the technical tail wings.
We have not been active new supply, but I think this might decelerate or even turn around to a headwind because we just have so much new supply from Japan, Australia, and Middle East and a lot of Asian investors are diversifying into this region. So that might have some big impact on the secondary curve. And the second one I'm thinking about is investors are turning quite comfortable with high-yield property credits in the region. A lot of the market participants are thinking this property saga is behind us, but we do still have some situational names waiting for liquidity and refinancing plans.
And if that does not work out, we might have credits contagion into the broader greater China banking sector as the overall Hong Kong CRE market is still quite sluggish. So these are the two I'm thinking about. Thank you. It's really nice.
We never like to hear the phrase credit contagion when we are on these types of webinars. All right. So my key risk and perhaps the country review is I don't know that fundamentals are at this point, as good as everybody seems to believe that they are in the labor market in the US. We have a falling participation rate that's historically not a great leading indicator.
Consumer fatigue is pretty evident in discretionary categories in the ACPI print, and we're starting to see some stall out in wage growth in credit markets. Interest coverage is already reset, meaningfully lower. This leaves less flexibility for any sort of e-bita headwinds or persistently high borrowing costs going forward. And it seems to me at this point, from a ratings downgrade perspective, there's not a lot of room for incremental positive momentum.
It kind of seems like ratings have a little bit more of a downward bias going forward. Now, Zach, we're going to end on a really cheery note here with the last question from the audience. And that would be, as you expected, you said, will remain independent from Treasury, or may there be an attempt to influence engineer long-term rates? What's that you, Zach?
I think the Fed ultimately remains independent, but there's definitely been long-term damage done with how much heckling the current administration has done on Chairman Powell and making a specter out of this remodel. I think in the long run, it's likely to keep inflation expectations a little bit higher and call on the question how much presidents in the future will be willing to lean on the Fed. So, ultimately, it stays independent. I think there is some damage done that will be reflected in market pricing going forward, but Fed's not going to get absorbed into Treasury any time soon.
We definitely hope not. All right, with that, we're back at the top of the hour. Time flies when you're talking global strategy. We're going to wind down our webinar, and I would like to say, we only had two thumbs down emojis today proving yet again that credit-side clients are truly the best clients.
Thank you for the self-esteem boost. Thank you for joining our discussion today. Now, we do love to hear from our clients. So, if you have additional questions, please reach out directly to any one of us or your sales representative.
Best of luck to everyone in the second half of 2025 before we know it. 2026 will be upon us, and we'll have a whole new acronym to use in our daily conversations. With that, we are going to end the webinar. Thanks, everyone.
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