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Global Credit Playbook – January 2025 Summary

Core Content

The Global Credit Playbook – January 2025 outlines the outlook for credit markets in 2025, emphasizing a moderate economic environment that is favorable for credit. While the first half of 2025 (1H25) is expected to remain relatively stable with good growth, moderate inflation, and steady rate cuts, the second half (2H25) is anticipated to be more challenging due to rising macroeconomic uncertainty and potential policy shifts.

The report highlights that credit markets are likely to perform well in 1H25, driven by low spreads and positive total returns. It suggests that investors should focus on specific sectors and instruments that are expected to outperform, such as US investment grade (IG) 10yr+ bonds, European IG 5-7yr bonds, and senior mezzanine debt. Additionally, loans are preferred over high yield (HY) bonds for excess returns, while US CCC bonds are viewed with caution due to higher rates and recent tightening.

Main Views

• Credit likes moderation: 2024 was a year of moderate growth, inflation, and policy rates. This environment is expected to persist in 1H25, although macroeconomic uncertainty is increasing.
• Positive excess returns in 1H25: With low starting spreads and expectations for a tough 2H25, the excess returns for credit are modest but positive.
• Strong total returns: Morgan Stanley forecasts total returns of 9%+ across global credit markets, driven by lower yields and significant rate cuts expected in 2025-2026.
• Shift in preferences: The report suggests a shift from low-step hybrids to high-step hybrids in the US and EU, and a preference for US IG 10yr+ and EUR IG 5-7yr.
• Sector preferences: In the US, financials and utilities are favored, while in Europe, LT2, utilities, industrials, media, telecom, and high-step hybrids are preferred. Energy credit is disliked in both regions.
• Asia IG underperforms: Tight spreads, tariff risks, and increasing supply are cited as reasons for underperformance in Asian IG credit, with non-China markets (especially Japan) preferred over China.

Key Information

Credit Market Forecasts for 2025

Key Themes

• M&A activity: Expected to rise by 50% in 2025, which could increase supply but not yet above-trend.
• Rate expectations: The Fed is expected to cut rates twice in 2025, while the ECB and BoE may cut more than anticipated.
• Macroeconomic outlook: The US is expected to see a gradual slowdown in growth, with inflation remaining sticky. The ECB is anticipated to shift to a more accommodative stance by mid-2025.
• Balance sheets: US IG and HY have stable coverage and high cash balances, making them more resilient to rate increases.
• Valuation insights: Spreads are historically tight, with the US Agg Bond Index showing strong total returns due to high yields relative to inflation and a steepening yield curve.

Summary of Recommendations

• Buy: US IG 10yr+, EUR IG 5-7yr, financials and utilities in the US and Europe, HY BBs in the US and EU, senior mezzanine debt, and non-China Asia IG.
• Sell/Stay cautious: US CCCs, energy credit, and HY bonds in the US and EU (especially in 2H25).

Risk Considerations

• Downside risks: Weaker growth and persistent deflation in China.
• Upside risks: A 'too hot' scenario with rising M&A activity and potential widening of credit spreads.
• Duration as a hedge: The report suggests that duration can act as a hedge against growth risks.

Analysts

• Andrew Sheets – Strategist, Morgan Stanley Research
• Aron Becker – Strategist, Morgan Stanley Research
• Vishwas Patkar – Strategist, Morgan Stanley Research
• Kelvin Pang – Strategist, Morgan Stanley Asia Limited

Conclusion

The Global Credit Playbook – January 2025 presents a positive outlook for credit markets in 2025, with strong total returns and moderate excess returns in 1H25. The report emphasizes the importance of sector and instrument selection, with a focus on US and European IG, senior mezzanine debt, and loans over HY bonds. While the second half of the year is expected to be more challenging, the first half remains credit-friendly and offers favorable investment opportunities.