Over the past 30 days, credit spreads have tightened meaningfully, supported by a de-escalation in trade tensions and renewed risk appetite among investors seeking value across both investment-grade and high-yield markets. This follows a period earlier in the year marked by significant spread compression, which subsequently gave way to a sharp uptick in volatility and a broad-based repricing of credit risk. Major asset classes—including corporate credits, leveraged loans, and sovereign bonds across both Europe and the U.S.—have experienced elevated price fluctuations. Long-standing correlations between asset classes have broken down, and markets have witnessed some of the most pronounced weekly moves in over four decades. Against this backdrop, risk assessment and value identification have become increasingly nuanced. Despite the challenges, markets have staged a robust recovery, recouping much of the ground lost in early April. The inflection point was a shift in tariff policy (another one), which triggered a reassessment of risk-off positioning and led investors to re-enter trades previously unwound amid heightened uncertainty. As volatility moderated, risk sentiment improved and demand for spread products began to normalize. In prior commentaries—considered optimistic by some colleagues—I did not anticipate the headwinds would intensify into a full-blown hurricane. Nevertheless, I advised reducing exposure to issuers with fragile capital structures, shrinking operating margins, and weakening free cash flows. That guidance remains valid. However, given the evolving macro and market landscape, a more targeted and sophisticated approach to credit selection and pool allocation is now warranted. In my opinion, going forward, investors should place greater emphasis on: 1. The strength and aggressiveness of some old covenant packages 2. The borrowers’ degree of diversification across customer and supplier bases 3. The cyclicality of businesses and revenue streams 4. The resilience of free cash flow generation As previously highlighted, it should not require a full-scale crisis—of which there are currently no imminent signs, with global growth merely moderating rather than contracting—to acknowledge that downside risks are mounting. Early warning indicators, including softening consumer demand and corporates opting to keep liquidity buffers, reflect a notable shift in the risk environment and a deterioration in the broader confidence channel. These evolving dynamics necessitate a reassessment of fair value credit spread targets. For lower-quality issuers, the confluence of macroeconomic headwinds and weakening idiosyncratic fundamentals strengthens the case for a decisive reduction in exposure. This should be executed with both urgency and portfolio discipline (the markets appear to be offering a second chance to reposition). Importantly, many of the structural vulnerabilities—such as elevated leverage, unsustainable capital structures, and challenged business models—were present well before the political developments associated with President Trump’s return to the forefront. This is a point I have consistently emphasized in conversations with investors: systemic fragilities in poorly capitalized or structurally impaired credits are not contingent upon U.S. policy outcomes. While political developments can act as accelerants, they are rarely the root cause of balance sheet distress. In Europe, we’ve already witnessed some painful restructurings, where investors incurred losses due to issuers failing to clean up their balance sheets in time. Debt trading at yields-to-worst (YTW) above 10% has made liability management exercises difficult, particularly for issuers excessively levered and struggling to generate cash flows. What are the doubts at this moment: **Credit Spread Behavior Absent a Recession** Can credit spreads widen materially even in the absence of a technical recession? Historical episodes such as early 2016 and late 2018 demonstrate that risk premia can reprice rapidly under conditions of market stress, even without a macroeconomic contraction. While the evolution of private credit markets has provided an alternative funding channel—thereby potentially cushioning defaults and distressed scenarios—it remains uncertain whether this dynamic will persist, particularly as stress begins to emerge in segments of the private debt space. Since Central Banks paused their rate-hiking cycles in 2023, one of the key challenges in credit investing has been the tendency to mix up the appeal of elevated all-in yields with the true compensation for credit risk — specifically, the spread component as a proportion of yield-to-worst (YTW). While absolute yields may appear attractive, in a historical context credit spreads on both investment-grade and high-yield assets currently trade well below long-term averages and we are dealing with levels last seen prior to the Global Financial Crisis. **Redefining Safe Haven Assets** In light of recent volatility in U.S. Treasuries—traditionally regarded as the risk-free benchmark—what assets, if any, can still credibly retain safe haven status? Beyond holding elevated levels of cash, investors must consider whether traditional government bonds still give portfolio protection, or if a reallocation toward low-beta credit, gold, or volatility-sensitive strategies offers a more robust hedge in dislocated markets. **USD Performance vs. Risk Sentiment** Why does the U.S. dollar remain relatively weak, even as equities and credit markets have staged a recovery? Is the USD now structurally negatively correlated with credit spreads or the term premium in U.S. Treasuries? This disconnect raises important questions about capital flows, global liquidity conditions, and the evolving role of the dollar in a multipolar currency environment. I have seen many European portfolios badly exposed to dollar assets, but the point today is to quantify the incentive for investors to hedge their US investments (forex stop loss, uncertainty, volatility level, correlation between assets). **Portfolio Construction in an Uncertain Environment** Given reduced macro visibility, does a barbell approach—combining highly liquid positions with select, less liquid credit opportunities—present a prudent or a better strategy? (some credit managers are already implementing this investment approach) In particular, should portfolios reduce exposure to large-cap issuers where ownership is fragmented across multiple creditor classes and where conflicting incentives among investors and those maturing with private equity sponsors may impair effective restructuring outcomes in periods of stress? **Redefining Safe Haven Assets** In light of recent volatility in U.S. Treasuries—traditionally regarded as the risk-free benchmark—what assets, if any, can still credibly retain safe haven status? Beyond holding elevated levels of cash, investors must consider whether traditional government bonds still give portfolio protection, or if a reallocation toward low-beta credit, gold, or volatility-sensitive strategies offers a more robust hedge in dislocated markets. **USD Performance vs. Risk Sentiment** Why does the U.S. dollar remain relatively weak, even as equities and credit markets have staged a recovery? Is the USD now structurally negatively correlated with credit spreads or the term premium in U.S. Treasuries? This disconnect raises important questions about capital flows, global liquidity conditions, and the evolving role of the dollar in a multipolar currency environment. I have seen many European portfolios badly exposed to dollar assets, but the point today is to quantify the incentive for investors to hedge their US investments (forex stop loss, uncertainty, volatility level, correlation between assets). **Portfolio Construction in an Uncertain Environment** Given reduced macro visibility, does a barbell approach—combining highly liquid positions with select, less liquid credit opportunities—present a prudent or a better strategy? (some credit managers are already implementing this investment approach) In particular, should portfolios reduce exposure to large-cap issuers where ownership is fragmented across multiple creditor classes and where conflicting incentives among investors and those maturing with private equity sponsors may impair effective restructuring outcomes in periods of stress? I remain cautious toward managers who assert that their portfolios are concentrated in issuers purportedly resilient to slower growth and trade-related disruptions. Such claims often lack sufficient analytical rigor or fail to fully account for IRR targets. I am even more skeptical of investors who emphasize an underweight allocation to high yield credits as a sign of defensiveness. Shallow statements. Why do we so rarely hear about portfolio strategies that seek to exploit issuer dispersion across credit ratings and maturities, especially when volatility creates compelling relative value opportunities? **Flow-Driven Market Distortions** To what extent are fund flows—particularly into and out of ETFs and structured credit vehicles—exacerbating price movements beyond what fundamentals justify? With U.S. credit markets recently experiencing the largest weekly outflows in over 15 years, and structured products under heightened scrutiny, there is growing concern that technical factors could sustain dislocated market conditions longer than rational valuation models would imply. Notably, ETFs remain largely untested in prolonged or disorderly selloffs. **Monetary Policy and Timing Risk** How will central banks—particularly the Federal Reserve—navigate the delicate balance between maintaining policy credibility and responding to a potential slowdown? Is there a risk that the Fed delays rate cuts for too long, thereby tightening financial conditions further and amplifying downside risks across credit markets? Deciding around the above points with sound judgment could help establish a more constructive foundation for making responsible and accountable investment decisions. As risks and underlying realities become more entrenched, clarity and discipline in the investment process become increasingly critical. “Moving up in quality or trimming high beta credits”, I reiterate, might not provide value to the European and American portfolios in this specific context and in the near future.

Doubts in the Financial Storm