2025 Credit Outlook: On Firm Ground, Despite Shifting Political Sands

15 January 2025

4 min read

New policies could disrupt markets, but high starting yields and strong demand for income should provide ballast.

2025 is ushering in new political regimes across the world, and with them a spate of untested policy proposals. Against this potentially disruptive backdrop, we expect credit markets to benefit from high starting yields, sound fundamentals and pent-up demand.

The election of Donald Trump to the presidency may signal lower marginal tax rates, higher GDP growth and increased protectionism in the US. In other parts of the world, we think growth rates are likely to be uneven after a year of punishing elections that exiled incumbents and injected uncertainty into the credit markets.

Will Tariffs Help or Hurt? It Depends

Protectionist policies carry both opportunities and risks. Stiff tariffs promised by the incoming US administration could hurt companies with long supply chains outside the US and benefit firms more heavily invested in US production. But they could also prove to be inflationary, ignite trade wars and batter Europe’s export-dependent issuers.

Even if US tariffs trigger retaliatory measures, it’s not clear whether the rest of world will fully embrace Trump’s brand of protectionism. Policy divergence between the US and Europe, along with a wide range of possible outcomes, could fuel yield volatility and return dispersion. In our view, this makes assessing relative value and security selection especially important.

Falling Rates Should Benefit Corporate Bonds

Central banks continue to ease monetary policy, but along different paths. With eurozone inflation coming under control, we anticipate that the European Central Bank will reach its policy-neutral goal by the third quarter. In the US, the Federal Reserve has already signaled its intention to slow the pace of easing and may fall short of its 2% inflation target in 2025.

As central banks ease and money-market rates fall, we expect investors to reinvest sidelined cash—currently at record levels—in higher-yielding corporate bonds, as has been the case historically under similar conditions (Display).

Money-Market Assets Have Historically Declined During Easing Cycles

Money-Market Fund Assets Under Management (USD Trillions)

Lines showing money-market assets under management declining during three periods of Fed easing since 2000.

Historical analysis does not guarantee future results.
Through December 31, 2024
Source: Bloomberg, US Federal Reserve and AllianceBernstein (AB)

In the meantime, elevated bond yields provide an attractive entry point for fixed-income investors. For example, investment-grade yields and yield breakevens are currently at or approaching historical highs.

Credit Quality: The Case for Middle Ground

Corporate fundamentals remain generally strong for both high-yield and investment-grade corporate bonds, but dispersion has widened across sectors and credit ratings.

At the top of the credit spectrum, the highest-quality investment-grade corporates have seen credit deterioration in the form of weaker interest coverage ratios (Display, left). By contrast, BBB-rated bonds boast EBITDA margins higher than those of securities rated A and above (Display, right)—a long-standing trend that we expect to continue in 2025.

Corporate Fundamentals Are Showing Dispersion

Bloomberg US Corporate Index

Lines showing interest coverage ratios declining for As since 2022 and EBITDA margins rising for BBBs in late 2024.

Historical and current analyses do not guarantee future results.
EBITDA: earnings before interest, taxes, depreciation and amortization
Through September 30, 2024
Source: Bloomberg, J.P. Morgan and AB

Owing to these sound fundamentals, we see some of the most compelling opportunities in BBBs and BBs—a sweet spot that could allow investors to pick up yield without a proportional sacrifice in credit quality. This includes select fallen angels—bonds downgraded from investment-grade status—that have either stabilized as high-yield companies or have a pathway back to investment-grade. And unlike CCC-rated high-yield credits, default rates among BBBs and BBs have historically been low. But here again, credit selection is critical.

Finding Value in the Belly of the Curve

We don’t believe today’s narrow spreads should deter investors from owning credit. Historically, tight spreads have tended to remain that way for some time.

However, valuations are a mixed bag heading into 2025, putting the onus on thoughtful yield-curve positioning. Valuations are particularly rich on the long end of the curve, where institutional investors are driving demand—narrowing the spread in yields between corporate bonds and US Treasuries.

Further in on the curve, spreads are wider and valuations are more attractive. We view five- to 10-year maturities—the belly of the curve—as particularly compelling, providing a nice balance of attractive yield and spread without the duration risk of longer maturities.

Strong Technicals Should Support Bond Prices

We expect supply and demand to remain supportive across global investment-grade and high-yield corporates—aided in part by steepening yield curves, migration from money-market funds and manageable levels of net issuance.

In Europe, investment-grade inflows slowed late in 2024 but were still well above 2023 levels. In the US, investment-grade inflows finished 2024 at their highest levels since 2020 (Display)—even with nearly $7 trillion of cash still parked in money-market funds.

Corporate Bond Inflows Are Running Above Historical Norms

US Investment-Grade Flows (USD Billions)

Bars showing 2024 US investment-grade inflows of $137 billion through September 30.

Historical analysis does not guarantee future results.
Through December 31, 2024
Source: J.P. Morgan and AB

Demand for credit could accelerate in 2025 if cash-heavy investors come off the sidelines. But the drivers of this demand are shifting. As the private credit market grows, the high-yield market is shrinking; at the same time, a growing portion of high-yield demand is coming from investors with high-yield and investment-grade crossover mandates. In our view, these dynamics will likely strengthen credit demand and keep spreads range bound.

The coming year presents myriad risks and policy uncertainty—potential harbingers of volatility that we feel are best navigated through active management, appropriate yield-curve positioning and prudent security selection. Regardless, we believe falling rates, sound fundamentals and pent-up demand make a strong case for investing in global credit markets in 2025.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

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