European high yield: Rise of the underdog

July 10, 2025

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As global investors look to add non-US dollar exposure, European high yield stands out as a stable, yield-enhancing alternative, as Thomas Samson and Jamie Cane explain.

As investors navigate a more complex macro environment marked by policy uncertainty in the US and diverging central bank trajectories, the case for geographic diversification has rarely been stronger.

While US high yield remains a core allocation for many global investors, Europe presents a differentiated opportunity that is becoming hard to ignore. A combination of attractive relative value, improving credit fundamentals and policy stability - underpinned by structural tailwinds such an end to German austerity and European Central Bank (ECB) rate cuts - positions European high yield as a viable alternative for investors seeking stable income, lower volatility and diversification.

Europe’s reawakening

While the US has turned its focus inward to boost domestic growth, Europe is pursuing a strategy intended to be resilient to tariff and trade-related tension. Among the most significant developments is Germany’s €500 billion infrastructure spending plan, which, in time, could boost the broader European Union and provide a tailwind for investors.

The region is also benefiting from an easing monetary policy bias, low unemployment¹  and low inflation,²  further helping to offset economic concerns. In addition, although US trade tariffs had been raised as a concern, when put into a broader context, only 20% of EU goods are exported to the US.³ 

Against this backdrop, we are seeing signs of increased appetite among global investors for European exposure, which could add further support to an already favourable technical in high yield.⁴

Tailwind from hedging costs

The divergence in US and European central bank policies is creating a meaningful difference in hedging costs; the 3-month forward currency hedging cost of exchanging euros into US dollars has risen from 1.6% in January to 2.4% (Figure 1). This can be explained by the more predictable trajectory of euro rates, unlike the US where outlooks vary widely. This acts as an incentive for dollar investors to move into euro-denominated assets, while dissuading European investors from allocating in the opposite direction.

This can have a meaningful impact on yields. For example, while the European high yield market is currently yielding 5.5%,⁵ and the US market 7.2%,⁶ after including the 2.4% hedging cost, euro assets become more attractive to dollar-based investors with a yield of 7.9%.⁷ The 2.4% portion is also locked in (risk-free) for 3-months, making the overall return more appealing on a risk-reward basis.

Quality over quantity

While traditionally viewed as riskier than investment-grade debt, high yield has seen a significant improvement in credit quality over the past 30 years.⁷  The credit quality of European high yield outweighs that of its US counterpart, with 66% of the market rated BB versus 52% in the US.⁶

Broadly speaking, we believe fundamentals are sound. While European growth is ‘moderate’,⁸ consumer-facing companies, usually the first to show signs of economic stress, are supported by low unemployment rates. Meanwhile, the real estate sector is recovering, aided by falling deposit rates and improving funding conditions.⁹ 

While we still see pockets of weakness, such as in the autos sector, we believe this is more likely to result in spread widening rather than the beginning of a default wave. Aside from well-known idiosyncratic situations in issuers facing a material fall in profits and unsustainable debt levels, we see little evidence of broader stress.

Robust technicals

The asset class is also benefiting from an extremely strong technical. Since late 2023, we have seen sustained inflows on the back of attractive valuations following 2022’s sell-off. This is being met by limited net supply (Figure. 2). Over the past two years, the face value of the European market has declined by 13%, due to the number of issuers upgraded to investment grade, the so-called "rising stars". In short, we have more cash chasing fewer bonds.

The supply-demand imbalance has also resulted in an increased ability to weather periods of market stress. This includes volatility-inducing events such as last year’s French elections or the Liberation Day tariff announcements, when spreads retraced quickly compared to previous risk-off events.²

Concerns about upcoming debt maturities have largely been mitigated. As fears of a European recession faded, companies successfully and comfortably accessed primary markets to refinance, despite the higher rate environment.

Carry and convexity

As a result of the strong technical and sound fundamentals, spreads are currently tight and could grind tighter still if nothing derails the market’s momentum. Indeed, the market has already retraced more than 75% of the April 2 US ‘Liberation Day’ sell off. 

However, unlike previous periods when spreads were at similar levels (2021 and 2017), today’s market has two key differences: carry and convexity. In 2017 and 2021, interest rates were negative, which had a direct impact on yield. Today’s normalised rate environment is meaningful for high yield as investors also receive ‘carry’ (all-in yield). The average cash price is just below par, in contrast to previous periods where they were above par. This convexity improves the valuation proposition.

In addition, dispersion remains high (Figure 3), making it the ideal environment for active managers to identify mispriced opportunities and avoid weaker credits.

Strategically sound

In a world where global investors are looking closely at their weightings to US assets, European high yield offers a compelling alternative. Backed by improving fundamentals, strong technicals and a more stable policy and rate environment, the asset class is benefiting from both structural tailwinds and cyclical opportunities.

With attractive hedged yields, a benign default environment and ample room for active management to add value through credit selection, we believe there is a strong argument for global investors to make a strategic allocation to European high yield.

 

References
1. Y charts, Eurozone Unemployment Rates, as of April 2025. Rate at 6.20%. Latest available data used.
2. Eurostat, as of 18th June 2025. “Annual inflation down to 1.9% in the euro area”
3. Eurostat, as of 31st December 2024. United States largest partner for exports, China for imports.
4. Reuters, ‘Investors pull out of US stocks and into Europe and emerging markets,’ June 11, 2025
5. ICE Index Platform, as of 23rd June 2025. ICE BofA Euro High Yield Constrained Index (HEC0).
6.ICE Index Platform, as of 23rd June 2025. ICE BofA US Cash Pay High Yield Index (J0A0).
7.ICE Index Platform, as of 23rd June 2025. ICE BofA US High Yield Index (J0A0) ICE BofA Euro High Yield Index (HE00).
8.European Commission, as of 19th May 2025. “Spring 2025 Economic Forecast: Moderate growth amid global economic uncertainty”
9.European Commission, as of 19th May 2025. “Signals of a turnaround in the housing market”

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of July 2025 and may change without notice.

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Index descriptions

J0A0: The ICE BofA US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period that is publicly issued in the US domestic market.  Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

HEC0 – The ICE BofA  Euro High Yield Constrained Index contains all securities in the ICE BofA  Euro High Yield Index (HE00) but caps issuance exposure at 3%.

HE00: ICE BofA Euro High Yield Index tracks the performance of EUR denominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch) and at least 18 months to final maturity at the time of issuance. In addition, qualifying securities must have at least one year remaining term to maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.

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