Solid US fundamental baseline ahead of policy changes

US investment grade (IG) credit fundamentals remain solid and leverage has continued to hold steady, with no sector experiencing a meaningful slowdown in Q4 2024. We believe we have seen the trough in revenue growth, which has begun to move higher in the US, reaching 2% in Q3 2024. There has been some slowing of momentum in earnings growth, but our median industrial bottom-up analyst estimate remains for moderate growth into the second half of 2025, with earnings growth averaging 5% and revenue growth over 3%. Looking at average growth over the last 20 years, we are at similar levels to the end of 2019. With a new administration coming into office our baseline could move higher or lower depending on policy action.

European fundamentals are following the US recovery

The decline in European growth appears to have bottomed as trailing 12-month year over year (YoY) EBITDA² growth for the median industrial company modestly accelerated in Q3 2024 to 2.4%. Revenue growth is still decelerating, albeit the rate of change looks to be slowing as growth approaches zero.

Gross leverage of 2.6x is close to the 20-year average of 2.4x and has remained steady for four quarters in a row. Net leverage of 1.9x is similarly close to the long-term average of 1.7x and suggests no deterioration in corporate health.

Healthy balance sheets are one factor driving the increase in merger and acquisition (M&A) activity this year, with a notable uptick in intra-European industrial M&A and international acquisitions of European companies.

Despite tentative signs of a bottoming out for EBITDA growth our analyst forecasts point to a subdued environment over the next two quarters before growth reaccelerates. However, we expect dispersion among sectors. The autos sector is still notably weak, followed by luxury retail. We think both sectors are set to improve, supported by new products, restructuring efforts and easier YoY comparisons, although tariffs could present a new headwind. Capital goods maintains the strongest outlook due to robust demand and pricing power, and large unfilled backlogs.

Assessing the potential impact of key US policy changes

We expect considerable policy changes under the Trump administration and note four main areas that could be impactful to US companies: tariffs; regulatory oversight; a lower corporate tax rate for companies that produce in the US; and changes to some of the provisions of the Inflation Reduction Act and the Chips and Science Act. With details still forthcoming, we have based our analysis on many assumptions and focused primarily on first order effects.

Taking into account these key policy areas, and assuming a 10% universal tariff, the overall impact on forward-looking US EBITDA estimates was neutral for just over half of the industrial sectors, with key trends remaining the same. The healthcare and technology sectors, which were expected to outpace others, will continue to do so. Sectors already seeing flat or declining baseline EBITDA growth, such as retail, consumer products and autos, will face additional pressure. The impact could be more punitive under more severe tariffs than we assume in our analysis. Midstream companies within energy emerge as a clear winner, as policy impacts would be a catalyst for growth, while utilities are not expected to be impacted. Banks are expected to benefit from regulatory easing, though we don’t expect major deregulation.

When looking at Europe, applying the impact of a 10% tariff across the board on goods exported to the US would result in a delayed rebound in European earnings growth from our base case. However, many large European companies have operations in the US so that exports constitute a relatively small percentage of US sales, dampening the effect of tariffs. European companies with pricing power, such as capital goods manufacturers, are expected to pass along price increases, while auto manufacturers, already under pressure, will experience greater margin and earnings deterioration.

Strong demand supports increasing global supply

Technicals remain a bright spot for IG credit. Demand for US IG fixed income from retail clients was robust in 2024, both from domestic clients and European clients buying USD-denominated funds. Foreign demand for US corporates, especially from Japanese and Taiwanese buyers, stepped up in Q3 2024 just as hedged yields started to move higher, offsetting some of the reduction in European buying in the second half of the year. 

This healthy demand is supporting the expected significant increase in supply. A combination of factors—a 21% increase in the maturity profile of the IG index YoY, and the potential for more M&A related issuance—are driving expectations for more supply across almost every sector in 2025. However, even with gross issuance in the USD 1.6 trillion – 1.7 trillion range (vs. USD 1.55 trillion in 2024), net supply is expected to be manageable with Covid-era five-year issuances coming due.

European demand for corporate bonds continues to run at elevated levels and is supporting the record run rates of supply. Maturing bonds from the negative interest rate and corporate sector purchase programme (CSPP) era are also driving refinancing activity. In the UK, established names are entering the European market with inaugural deals, such as Gatwick and Seven Gas Network, attracted by the pricing and depth of the euro market. With high runoff rates, this trend is shrinking the UK market, creating a strong technical backdrop.

Opportunities from high all-in yields and policy-driven volatility

In line with our expectations throughout 2024, valuations across the board are approaching the narrower side of history. IG credit spreads (as measured by the Bloomberg Global Aggregate Corporate Index) tightened by 26 basis points (bps) over the year to 88bps. If we consider credit spread moves at the market level, USD spreads tightened by 19bps to 80bps, EUR spreads tightened by 35bps to 103bps, and sterling spreads tightened by 43bps to 96bps.

Historically, when US IG credit spreads trade inside 80bps, yields are almost always at or above the 2024 year-end level of 5.3%. During periods of higher all-in yields, credit spreads tend to be more compressed. In the two periods (mid-1990s and mid-2000s) where spreads traded around current levels for sustained periods of time, yields were close to or above 5.3%. As a result, we believe the recent sell-off in rates is supportive of IG credit maintaining these tight spreads over the longer term.

Over the last 25 years, corporate bond spreads, on average, have not cared whether a Republican or Democrat is in the White House. However, there is a meaningful difference at the sector level, where banks, basic materials and energy have all traded tighter during Republican presidencies. Driven largely by less regulation during Republican administrations, banks have historically traded on average at approximately 82% of the index option-adjusted spread (OAS) vs. 95% today. We expect to see similar trends as we move through 2025.

Our best ideas for portfolios

Considering the current environment and taking into account the potential policy changes, we see opportunities in both US and European banks. In the US, we think the potential for less regulation will benefit both large global institutions and regionals. In Europe, banks engaging in M&A look attractive while heavy supply for French bank bonds in January continues to present buying opportunities.

US utilities are likely to benefit from increasing power demand and immunity to tariff noise, while midstream energy companies should be net beneficiaries of opportunities created by expected policy changes, with a key area of focus in the hybrid space.

Finally, headlines around tariffs could create volatility and provide opportunities to add EUR exposure. We see some opportunities in companies with strong margins and/or pricing power, such as in the capital goods sector.

¹ Global systematically important banks

² Earnings before interest, tax, depreciation and amortisation