Now is the time for European high yield investors to consider going global

The situation in the Middle East remains fluid; however, a few implications have emerged that are likely to affect credit fundamentals. Rising energy prices have already impacted inflation around the world, and although oil prices appear to have passed their peak, we think they are likely to remain above pre-war levels. Capacity has been destroyed and will take time to rebuild.

These pressures will be felt most strongly in Europe and Asia, which are more reliant on energy imports than the US. Higher energy prices also feed through into fertiliser and pesticide costs, adding pressure to food prices. We note that credit fundamentals globally remain reasonably strong, and we do not expect a rapid increase in default rates, but we believe the momentum is more likely to turn negative in Europe than in the US within the same rating categories.

The US is not immune to inflationary pressures, of course. We expect interest rates globally to remain high and potentially rise further. Leverage and interest coverage ratios in Europe and the US are broadly similar and, with average interest coverage of around 4x, there is meaningful capacity to absorb higher refinancing costs (Exhibit 1). But the European refinancing wall is larger than the US one as a percentage of market outstandings (Exhibit 2). This means European companies will need to refinance earlier, while also facing higher rates and weakening fundamentals.

Based on this analysis, we believe the US is currently more appealing than Europe for high yield bond investors. Some parts of the Latin American and African markets may also benefit from lower energy prices; however, the size of these markets is significantly smaller than the US. 

Given our expectation of an inflationary environment, it’s worth mentioning that, as an asset class, high yield across all regions can benefit from inflation. When it supports nominal earnings while debt remains unchanged, for example, this can allow for faster deleveraging. In addition, if all-in yields rise, the need for allocations to equity and less liquid asset classes may fall, which can provide technical support for the market.

A key argument for a global approach is that it offers investors a larger universe of high yield bonds – more issuers, more sectors, deeper liquidity and a broader opportunity set. Exhibit 3 highlights that credit spreads in Europe and the US are similar. Given our view that the US offers more defensive credit-fundamental momentum, this appears mispriced and allows European investors to move global without giving up spread.

In prior years, the yield give-up from the US dollar into euros made non-euro credit expensive for euro investors. However, that cost has fallen since 2024, and hedged yields for global high yield are now very similar to those of euro high yield (Exhibit 4). Our core expectation is that annual hedging costs are likely to fall by 25 basis points by the fourth quarter of this year, driven by the convergence of European and US three-month interest rate expectations. In that case, they will be close to the lows seen since the pandemic.

History also supports the case for staying global. No single high yield market has led performance consistently over time. Return leadership across European, UK, US and emerging market high yield has rotated frequently from year to year, with meaningful differences between the best and worst-performing regional markets (Exhibit 5). For investors, that is a powerful argument against a static home-market allocation and in favour of a strategy that can move dynamically toward the most attractive opportunities as valuations and fundamentals change.

Importantly, choosing global does not mean giving up the attractive features of European high yield. Europe still offers appealing spread and quality characteristics, and we see clear value in selected parts of the market. The advantage of a global strategy is that it allows clients to retain that exposure while avoiding unnecessary concentration. It also enables a more selective stance towards the weakest credits, where default risk remains concentrated in B- and lower-rated issuers with thinner equity cushions and weaker liquidity. In our view, the ability to combine higher-quality European exposure with the best opportunities from the US and other markets is a much stronger proposition than remaining confined to one region.