Low tide, sharp eyes: What to pick up

After the havoc caused by the April 2 “Liberation Day” storm, there was plenty of wreckage to sift through in credit markets, but spreads are now tight and volatility is low. The easy finds have been pocketed. What remains requires a beachcomber’s patience — slow steps, sharp eyes, and a sense of what’s worth keeping versus what just glitters in the sand.

The good news: Structural tailwinds such as fiscal stimulus, deregulation, and AI investment keep the backdrop constructive. The challenge: With valuations elevated across most sectors, success depends on selectivity. We’re maintaining a moderately defensive posture while staying disciplined about where we hunt for value.

A shifting macro tide

US policymakers are navigating a tricky stretch. Inflation has moderated but remains sticky, with renewed tariff pressures and tight labor markets likely to push prices higher. Consumer and corporate balance sheets remain healthy. Fiscal support from the One Big Beautiful Bill Act, deregulation, and robust AI-driven capital investment have offset cyclical softness but the unemployment rate, though still low by historical standards, has risen. Combined with growing pressure from the US administration, this is prompting an increasing number of Fed officials to argue that rates should shift lower from what they perceive as still restrictive levels.

But what does this potentially lower-shifting macro tide mean for credit investors? Credit spreads, especially in US high yield, sit near historical tights. Technical factors like persistent yield-chasing and light issuance have kept valuations buoyant. The best shells have already been picked up and broad credit exposure offers poor risk/reward. In such an environment, we think a more selective approach makes sense: seeking securities with attractive upside relative to downside, strong structures, and resilient fundamentals.

What’s most worth picking up?

Securitized credit
The foundation here is solid. Low housing inventory, high homeowner equity, and conservative underwriting support our constructive view on select residential mortgage-backed securities (RMBS), asset-backed securities (ABS), and commercial mortgage-backed securities (CMBS), as highlighted in Figure 1. These sectors offer attractive yields backed by resilient consumers and disciplined lending. The opportunities here may not be flashy, but they are likely to be durable.

European high yield
Though performance has been strong, European high yield still trades at a discount to the US. We see notable opportunities in REIT debt and Additional Tier 1(AT1) bank capital from quality issuers. Germany’s fiscal expansion is improving fundamentals, particularly in defense and infrastructure. Sharp-eyed investors can still uncover potential pockets of value here.

Convertible bonds
Convertibles offer upside participation if equity markets rally, and downside protection if the cycle turns negative. We favor issuers in health care, pharmaceuticals, and industries benefiting from AI-driven transformation. Among all segments, this feels like the rare stretch of beach still yielding interesting finds.

Figure 1

Shallow rewards but still reliable finds

Bank loans
Floating-rate loans provide solid income and better loss-adjusted carry than high yield. At prices near or slightly above par, though, they offer limited room for capital appreciation. Worth holding, not worth chasing.

Credit derivatives
Index derivatives like high-yield CDX and iTraxx Crossover offer efficient exposure and roll-down potential. These work well in stable markets with a supportive technical backdrop. They provide a tactical way to express credit views while staying flexible if unexpected storms roll in.

What to leave on the sand

US high yield
The risk/reward equation looks poor. Tight spreads leave little cushion: Even modest widening would cause these bonds to underperform Treasuries. We’re staying highly selective here as most of what’s visible isn’t worth bending down for.

Mezzanine CLOs
These tranches are vulnerable if economic conditions deteriorate. A weak risk/reward profile and sensitivity to defaults make them risky across most scenarios. Better to leave them buried for now.

Emerging market debt sovereigns
Long durations and tight spreads make most hard currency sovereigns — government bonds denominated in US dollars and euros — unappealing. We see value in select African names and potential fallen angels. Local currency sovereigns tell a different story, with more value but, overall, this stretch of beach looks picked over.