Laying out ideas for 2025 is a challenging task, considerably more complex than in the previous two years. The years 2023 and 2024 offered clearer opportunities, largely due to the aftermath of significant losses in US and European credit portfolios during 2022. These losses created, in my opinion, a natural setup to capitalize on duration and credit spread tightening. The year 2022 was a disastrous period for credit markets, the full ramifications of which remain only partially understood by many professionals. However, the impact was deeply felt. (The same lack of comprehension occurred in Q4 2018, when many investors remained surprised, passive, unable to implement effective hedges or provide sound explanations to investors of what really happened.) Investment-grade (IG) credit recorded return losses of approximately 15%, while high-yield (HY) credit declined by 12%. The fast and aggressive policy tightening by global central banks drove broadly similar negative returns across the US and Europe. Long IG positions posted losses of 20–22%, and certain HY sectors were severely dislocated. Bank spreads and real estate, for example, registered negative excess returns of roughly -25% over the 12 months of 2022. The dislocations in 2022 were stark: only 10% of the European HY segment achieved positive excess returns. Sectors such as airlines, healthcare, and food were among the rare exceptions. By mid-2022, the BB-BBB spread differential in Europe had widened to nearly 300 basis points (bps), while the CCC-B spread reached a staggering 850–900 bps during the summer months. These figures underscore the depth of stress in the credit markets at the time. In contrast, the financial years 2023 and 2024 were characterized by a pivot toward carry trades and alpha generation across various industrial sectors and specific credit names. Default rates, while increasing from the historic lows of 2021–2022, remained contained below 3.5%. Supportive liquidity conditions and solid credit fundamentals underpinned a benign default environment. Distressed ratios—defined as credits with an option-adjusted spread (OAS) above 10%—narrowed steadily for 24 consecutive months. Even credits with complex or speculative stories were buoyed by favorable market conditions, reflecting the well-known adage that "a rising tide lifts all boats." The year 2023 was notably marked by significant compression in credit spreads. BB and B-rated credits delivered robust performance in sectors such as consumer goods, utilities, media, and services. Meanwhile, 2024 emerged as the year of heightened anticipation for interest rate cuts. These materialized in Europe in June 2024 and in the US in September 2024, following the rate hikes that dislocated all asset classes. The timing of these cuts was driven by evolving macroeconomic assessments, including adjustments to growth forecasts and a revaluation of core and general inflation trends. The credit markets in 2024 exceeded even the most optimistic forecasts, delivering stronger-than-expected performance in both total and excess returns. In Europe, for instance, IG credit achieved total excess returns of +3%, while HY credit posted +6%, significantly outpacing the more conservative expectations at the start of the year. Initial forecasts, which predominantly emphasized coupon/carry strategies with only modest credit spread compression and limited capital gains, were exceeded as spreads continued to tighten. Despite entering 2024 with valuations that were widely regarded as rich, several sectors performed exceptionally well, vastly outperforming the broader HY index. Key outperformers included real estate, insurance, energy, capital goods, subordinated bank debt, and hybrid instruments. CCC-rated credits also delivered notably higher returns compared to other rating cohorts, driven by an environment of ample liquidity and risk-on sentiment. MM funds' rotation into yielding assets can explain a significant percentage of credit performance and compression. The other percentage is explained by the US economy, which performed better than the soft-landing scenario penciled into many investors' notebooks (less difficult to understand in the case of Europe). These credit dynamics unfolded in an environment marked by robust gross issuance volumes, which were double those of 2023 and 3.5 times the cumulative levels recorded in 2022. The 5-7yr duration segment was the favorite choice for corporates, which remained less active in the short part of the curve. Refinancing activity accounted for the largest share of proceeds. The leveraged loan market also delivered standout performance, ending 2024 with total returns exceeding +8.5%, following an exceptional +13% return in 2023. The CLO market continued to play a pivotal role in maintaining robust demand for the asset class. However, recurring waves of repricings acted as a cap on loan prices, particularly for those names nearing their call dates. **What can cloud the picture?** The majority of outlooks from research houses and market participants maintain a positive bias as we approach 2025. While I align with a cautiously optimistic perspective, several critical considerations warrant closer scrutiny. Calm in headline indices does not reveal what is happening under the surface where some credits are clearly short calls (no surprises there). Let’s see: **a) Risk tolerance dynamics:** Investors' risk tolerance may shift in response to heightened volatility in yield curves, particularly in US Treasuries and European government bonds. Recent turbulence following the Federal Reserve's latest policy meeting underscores the susceptibility of markets to sharp repricing under unstable conditions. Since the FED's first rate cut, the 10Y Treasury yield spiked up by 90 bps. As I wrote many times, in Europe, credit stability or positive markets can be reached only with govies’ curves trending down and with low volatility in swap rates. An analysis at the country level seems paramount if we consider France and Germany and the uncertainty of political stability for corporate businesses. **b) Persistent uncertainty in price stability:** The trajectory toward sustained price stability remains opaque, particularly given the potential imposition of trade tariffs. Such measures are likely to impact a broad array of sectors, with consumer goods companies facing margin compression due to cost pass-through challenges and disrupted supply chains. Changes in tariffs set up a new world and present special challenges. Many investors are asleep to this new credit world (they had a small taste in 2018-2019 during Trump’s previous mandate). **c) Structural weakness in the European economy:** The European economy continues to exhibit signs of structural fragility. The ECB's revised growth forecasts highlight the subdued nature of the recovery, while expectations for meaningful gains in real incomes remain tenuous (The ECB is more optimistic on this point, and I do not know the reasons). This precarious backdrop limits the scope for organic demand-led economic acceleration. The Euro area remains trade-dependent for its growth; unusually, policy uncertainty does not help and does not stoke corporates’ investments. **d) Elevated risk in high-yield credits:** High-yield issuers with stressed capital structures offer increasingly unattractive risk-adjusted returns at current yield-to-worst (YTW) levels. Beyond leverage metrics, loan-to-value (LTV) considerations are critical yet often overlooked in distressed situations. Many high-yield investments exhibit limited recovery prospects, underscoring “the inadequacy” of remaining invested (or opening new positions) in such credit profiles absent a robust margin of safety or at least some sort of visibility. **e) Sector-specific vulnerabilities:** Certain sectors, such as automotive, face pronounced headwinds from declining sales volumes, which exhibit strong correlations with other industrial value chains. Borrowers with cyclical revenue streams, particularly in Europe, present heightened risk profiles. Persistently weak operating momentum observed for some borrowers in 2023 has extended into 2024, with no material catalysts to justify exposure to underperforming credits or over-levered capital structures with flat or negative free cash flow generation. A&Es solutions do not solve what cannot find remedy. **f) Compressed US credit spreads (and Europe as a follower):** US credit spreads remain at historically tight levels, posing challenges for portfolio construction and allocation strategies. The relative value of credits is increasingly constrained and should necessitate a more discerning approach to risk premia. I disagree with many analysts on the current levels of credit spreads in the US and Europe. Credit is not only priced to perfection but mispriced against forward-looking fundamentals and risks of impairment, and this remains valid on both sides of the Atlantic. The B cohort remains the most stretched, in my opinion, with limited cushion from near- and mid-term tail risks. “Many people think they are thinking when they are merely rearranging their prejudices” (quote from William James, American philosopher and psychologist).

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Two years in review, possible outlook