Euro credit: Investment potential amid global uncertainty

Credit markets entered 2026 on a solid footing, but the landscape has since shifted significantly.  What began as a year of macro optimism was tested by two successive shocks: AI-driven disruptions to private credit, and latterly, the Middle East conflict which reignited stagflation fears. However, despite this backdrop, the asset class has demonstrated notable resilience.

Disruptions take hold

At the start of the year, the credit landscape was buoyed by several favourable factors; global economic growth was showing signs of resilience, while decelerating inflation provided room for central banks to maintain accommodative policies, which helped sustain investor confidence. 

The overall environment was marked by a belief that credit spreads would remain relatively contained, and issuance activity was expected to stay robust.

However, the world has changed since then. Initially, a key driver of this was artificial intelligence-related disruption to business models in sectors such as technology, information technology services and media. 

The immediate impact was felt in the software industry, where AI's transformative potential threatened to displace existing business models and challenge traditional revenue streams. 

This backdrop spilled over into private credit markets given their significant exposure to software and technology issuers. As investor confidence waned amid uncertainties about AI's impact, stress levels increased in these segments.

Adding to this strain, business development companies, which often provide financing to middle-market firms and private debt groups, restricted withdrawals from their private credit funds. This move triggered a wave of redemptions across BDCs, further eroding investor confidence and intensifying market volatility. 

For euro credit investors, exposure to the software sector across both investment grade and high yield indices is very modest, while direct BDC exposure is also very limited. Having said that, this episode served as a reminder of contagion risk across private and public credit markets and reinforced the case for liquidity management.

Geopolitical tensions complicate the backdrop 

The outbreak of the Iran conflict has dominated headlines and amplified macroeconomic uncertainties. This, coupled with surging commodity prices and fears of supply chain disruptions, has fundamentally shifted investors’ expectations regarding growth, inflation, and monetary policy.

The prospect of prolonged higher oil prices and ongoing supply chain restrictions has raised fears of stagflation, a scenario characterised by stagnant growth coupled with rising inflation. This has led to a sharp sell-off in rates, especially in the short end of the yield curve, reminiscent of the market behaviour seen during 2022. 

The underperformance of short-term bonds reflected fears of aggressive tightening or ongoing inflationary pressures. In contrast, credit markets experienced more muted reactions. While spreads widened, the move was less severe than some might have expected given the geopolitical backdrop. 

Investment-grade and high-yield euro credit spreads widened by approximately 10 and 55 basis points respectively in March. Compared to last year's ‘Liberation Day’ episode, where spreads widened by 25 and 105bp, current movements suggest a strong market from a technical perspective.¹

Higher yields 

The rate sell-off, while causing spreads to widen, also improved the overall yield environment. Higher yields are attractive to investors seeking income, and this dynamic prompted some aggressive buying activity. 

The overall investment-grade credit index widened modestly by 10bp, with sector-specific underperformance observed in real estate, automotive, and subordinated debt. 

Defensive sectors such as utilities, consumer staples, and telecommunications exhibited greater resilience, reflecting their perceived safety during turbulent times. The high-yield segment also experienced widening, with spreads increasing by 55bp, notably among lower-rated bonds like single B and CCC categories.²

Market activity and investor sentiment

Despite these challenges, primary markets remained highly active. During the quarter, approximately €225 billion of new issuance took place, aligning broadly with the first quarter of 2025. Nearly €18bn was issued in the high-yield segment.³

The demand for new bonds remained robust, even during a turbulent March, underscoring the appetite and available cash among investors. However, flow dynamics were mixed: while inflows into investment-grade bonds slowed, they continued positively on a year-to-date basis, whereas high-yield segments experienced some outflows.⁴

For risky assets, the primary risk on the horizon is a shift in recession expectations. As such, if economic growth prospects weaken further or recession fears intensify, this would lead to spreads widening reflecting weaker prospects. Also, outflows could accelerate, particularly from credit asset classes perceived as riskier.

For now, while we acknowledge that geopolitical uncertainties may affect investors’ sentiment and rates volatility, our base case scenario sees a gradual normalisation. 

While uncertainty is likely to dominate macroeconomics in months ahead, fundamentals (such as leverage ratios and credit metrics) continue to appear sound in both investment grade and high yield. 

The recent rate sell-off has driven bond yields higher, creating attractive entry points for the credit asset class. Meanwhile, yield buyer demand should remain intact providing a support to credit spreads. 

We believe that credit selection and active duration management are critical, especially in light of the ongoing potential for rate volatility and the possibility of European Central Bank interest rate hikes.

Looking ahead

In the coming weeks, the path for oil prices and its impact on growth, inflation and monetary policy, are likely to continue influencing credit risk sentiment. However, the disruptive effects of AI and stress in private credit markets may resurface as dominant themes. The overall environment remains fragile albeit not disorderly, but there is the potential for further volatility.

In this environment, we maintain a constructive but selective stance on euro credit. We favour investment-grade issuers with strong balance sheets and see selective opportunities in BB-rated high yield, where the carry is attractive relative to default risk. 

Active management of duration, credit quality, and sector allocation will be essential to navigate the evolving landscape.

Ultimately, while headwinds persist, credit markets are demonstrating resilience. With prudent risk control, we believe investors can continue to capitalise on potentially attractive yields and the ongoing search for value amid uncertainty.