**Todo lo miro’, y noto’ y puso en su punto. (He noticed it, took note and put it in its place): Donald Trump? No, Miguel de Cervantes in the novel El Licenciado Vidriera. (Spanish writer 16 century).** But the last days deserve another quote: **“Who knows the end? What has risen may sink, and what has sunk may rise”. H.P.Lovecraft. (American writer of fantasy, horror and science fiction)** Financial market volatility surged in early April as the disorderly unwinding of bullish positions, risky trades, and leveraged positions intensified the market’s reaction to President Trump’s announcement of tariffs against the U.S.'s trading partners. According to the President, these measures were aimed at making things “fair” and putting an end to America being “ripped off.” The result was financial chaos, with markets thrown into a tailspin and rocked by days of massive price drops and significant volatility. Though signs of fragility had already emerged in Q1—triggered by weak data and the Federal Reserve’s decision to maintain a hold on interest rates—the most intense market movements occurred last week. Equities, currencies, options markets, and credit markets were all caught in the storm, leaving many analysts predicting the looming threat of a global recession. The European credit market saw heavy sell-offs in both investment-grade (IG) and high-yield (HY) sectors, with yield spreads widening sharply. Credit indices and cash prices fluctuated dramatically, causing alarm among investors. Some chose to sell, while others saw opportunities to buy, but many simply refused to accept the reality of what was unfolding. Credit spreads quickly adjusted in response to the developments, and by the end of the week, the market had closed with far more uncertainty than well-considered, tactical investment strategies. Discussing the intricacies of how tariffs are calculated or implemented is ultimately pointless, despite attempts by some to dissect the formulas—such efforts are frankly absurd. The writing has been on the wall for weeks: the credit market had become excessively tight, and Europe, until just ten days ago, had been surprisingly unaffected by the widening trends already taking shape in the U.S. credit markets. High-yield spreads in Europe during the first quarter of 2025 only widened from the lows by a third compared to what was happening across the Atlantic. This divergence was not consistent with the global economic and political environment, nor with Europe’s own inherent issues. Last week, the strain proved too much, and the market collapsed, with sentiment turning sharply bearish. What was initially seen as a bargaining instrument—the tariffs—quickly morphed into a harbinger of catastrophe. Investors didn’t hesitate to sell everything they could; the high-stakes tactics led to a swift market crash in the short term. The medium- and long-term outlooks, as of now, remain barely constructive. **Where does the European credit market stand at the start of Q2?** A) Analyzing the statistics on the recent market decline—focusing on where current levels stood in the HY bond market or the leveraged loan market in the previous months—is ultimately futile. I have long recommended abandoning this approach in favor of a more pragmatic strategy for managing credit exposure. The support levels we have in mind may have been relevant five or six or nine months ago, but that market was more bullish then, driven by a “risk-on” mentality and demand for yield after many years of low interest rates. That is no longer the case today. We should not assume the future will look mostly like the past. B) The high-yield credit market is often described as the “canary in the coal mine” for broader macroeconomic shifts. Investors in leveraged finance tend to be more prepared and sensitive to economic downturns than equity traders, given that the assets they invest in have inherent default risks even in favorable conditions. The direction of the high-yield market typically leads other asset classes, and the recent drop tells us that it’s clear that something in the sentiment has changed and shifted. In the US markets the HY credits widened before the global markets 'meltdown. Many did not focus on that. C) At the beginning of the year, strategists advised investors to focus on the "three Rs" of risk: recession, rates, and rotation in the portfolios. They recommended “carry trades” with some convexity. However, they overlooked the “T”—Trump. Sticking to the same course in such turbulent times only leads to poor results. Trump is no longer viewed as a cheerleader for risky assets, and we will see whether financial markets continue to act as a barometer for his economic agenda as they did in 2018. For now, credit portfolio managers should begin selling names and sectors most vulnerable to trade frictions—areas and companies that are already well-known. What should be underway is an understanding that the rapidly changing economic and policy landscape demands transformational investing and continuous review of sector weightings. The last trading sessions are not just showing us an upward pressure on spreads or a return to yield premiums, as I cautioned months ago. I disagreed in January with investors who expected a conducive environment for risk assets. I am maintaining my point of view because the backdrop is weak. If inflows succumb to outflows (and we will soon see the data), the challenges will worsen, and the supportive technicals for both low and high beta assets will vanish. Investors must recognize that looking at past levels for guidance is not useful, as risks are now piled up across the board. D) The yield spread correction expected in the second half of the year arrived just two months into 2025. During the bullish rally of the past quarters, the rising tide lifted all boats, compressing the normal dispersion among European high-yield borrowers (a topic that always finds me in disagreement with some strategists who confuse yields with fundamentals). In a bearish market, companies with leverage issues, unsustainable balance sheets, or low or negative free cash flows will be downgraded, and investors will suffer losses in LMEs. This is independent of whether the market is in a “bear” phase or simply undergoing a “correction,” as some experts would prefer to call it. In Europe, I can identify more than 10-12 names that could deliver unpleasant surprises in the coming months. Underneath the bullish surface of a positive credit market, several companies have remained in precarious positions casting doubts on the ability to meet debt obligations on current terms. Some borrowers suffered a reduction in profitability or a change (you can read this word also as “a challenge”) in the business model that I consider structural, and as such, I tend to dismiss those credits as part of an opportunity set. They are investment traps. If tariffs remain 'the most beautiful word in the dictionary,' as President Trump has said, this will not prevent European companies from facing other problems, such as inconsistent free cash flows to support high gross leverage, depleted cash balances, and negative outlooks caused by weak credit metrics. One key lesson learned over the past few months is that senior unsecured notes (a market that did not exist in Europe until 2013) were mispriced, in the positive credit run of 2024, relative to their risk, and the emerging headwinds have rendered these bonds highly vulnerable, with minimal recovery potential. SUNs valuations for weak issuers stopped being attractive in mid-2024 (who remembers the spread SSNs-SUNs at 270-290 bps in 2022?) although some investors still remain convinced about their wrong bets placed time ago and up until recently. I know many funds and CLOs unfortunately, that did not stay close to target- or investment philosophy- in their credit allocations, reflecting the ongoing chase for yield in a market grinding tighter and repricing high margin securities. Today, despite being underwater, SUNs investors attempt to position themselves at the LME tables, trying to impose their own views and create impossible and unstable structures to protect their interests and minimizing (you can read this verb also as “delaying”) losses. SUNs bonds are underperforming because some borrowers who used them have horrendous credit profiles. It is more than Trump’s earthquake. E) Low-yielding assets are particularly “prone to rotation”, as the CLO market is starting to deem them unsuitable for inclusion in asset portfolios or warehousing lines. This is one of the primary reasons European leveraged loan prices are falling. Looking at the ELLI index, the last time it was observed at around the 97 level was in April of last year. Back then, the weighted average cost of capital for European CLOs was between 235 and 240 basis points above Euribor. It is likely that today, with the financial markets’ rout, we are wider than that. Asset pools wherever they are, CLOs up and running or Warehousings, with an average spread of 350-365 bps (widely chased and justified in the portfolios even when the CLO structures priced or reset at WACC of 205-210 bps) don’t work in this environment. Absolutely not. CCC-rated names are increasing, and some portfolios have seen a higher percentage of credit names quoted below 80 cents. We appreciate and know that CLO vehicles are resilient, but CLO paper investors are rightly demanding higher yields on the notes, including AAAs, AAs and As (Relative value considerations are back. I wrote one month ago about the upper part of capital stack, advising not to rely only on ratings at the moment of purchase). The mezzanine notes are in a price’ discovery exercise. Remaining constructive on ABS does not mean refraining from reaching out to CLO managers asking higher returns on structured paper in primary deals or looking for better terms in secondary market diversifying the holdings by duration. Equity stories in capital stacks remain more complicated and are too lengthy to explore in detail here. Some investors and analysts continue to have foggy ideas on the asset class despite having all the statistics at hand (or maybe something it is still no clear from outside manager origination structures? It is prudent to stop here). I am very interested to see how the ETFs on CLOs will behave during the next weeks (they are tested for the first time by a bearish market). F) A brief note on the European Supervisory Authorities’ joint report on securitization regulation published on March 31: I have been asked about the implications or problems for CLO risk retention rules and market practices. Perhaps there are some, but only CLO platforms and their investors fully understand the language used in their originator structures. What the report makes clear is what was already known among managers, investors, lawyers, and structuring banks. The new report should not come as a surprise, as the previous EBA document, published in April 2022 and endorsed by the European Commission three years ago, outlined similar concerns. Furthermore, by broadening the definition of “Sponsor,” the Authorities acknowledge a sensitivity to third-party origination vehicles that may not align the interests of the sell side with those of the buy side. Therefore, the weakness observed in the European leveraged loan market last week cannot, under any circumstances, be attributed to the new EBA report. The European CLOs, as they always do, will adapt to the new regulatory framework. The ABS world is facing other big problems at this stage. For those who were caught off guard by the 02nd of April, the “Liberation Day” of the Trump administration and his unique approach to global trade and other matters, I recommend revisiting the book Fire and Fury by Michael Wolff, published in 2018. A few lines from this book, written seven years ago, could shed light on the President’s actions during his second term and offer insight into his worldview and behavior: 1.“...the challenges of the Trump administration have included dealing with off-the-record or deep background material that was later casually put on the record; sources who provided accounts in confidence and subsequently shared them widely; a frequent inattention to setting any parameters on the use of a conversation; a source’s views being so well known and widely shared that it would be risible not to credit them... the sharing or gobsmacked retelling of otherwise private and deep-background conversations” (from the Author’s note) 2.“The paradox of the Trump presidency was that it was both the most ideologically driven and the least. It represented a deeply structural assault on liberal values”(from chapter 13). The U.S. credit market typically favors visibility and moderation to tighten and remain tight. This is clearly not happening now because the positive narrative is under question. The U.S. is widening, and Europe is following. A market correction or dislocation sometimes is a great starting point for further and more careful market analysis and credit portfolio positioning. This is what I usually encourage.

Hunting for Supports