Outlooks

Q1 2025 Leveraged credit outlook: Allocating amid market optimism

Public credit markets are priced for full optimism, but do tight spreads reflect a realistic outlook or complacency in the market?

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January 24, 2025 | 10 minute read

Key takeaways

  • Public credit spreads are priced for full optimism despite credit fundamentals declining. Private spreads offer compelling value.
  • Higher for longer may continue to support attractive public credit yields, but credit losses may continue to rise.
  • Better relative value, structure and terms to continue support private credit performance. Public credit may present value on a tactical basis.

The past two years have been stellar for credit investors. The Fed’s rate hike cycle was presumed finished in mid-summer 2023, and credit settled into the start of the higher for longer interest rate regime. The much-feared Fed-induced recession never occurred, and the U.S. economy’s dogged resilience became the envy of the developed world.

Against this backdrop, credit defaults have remained largely contained, inviting investors into yields that have produced an attractive level of income-driven total return. In high yield, we’ve noted a variety of other compelling attributes supporting a favorable view of the asset class over the past 12 months.

However, as we sit here today, we believe the optimism in public credit has gone too far. While private credit is not immune from certain of the risks present in public credit, substantially higher spreads provide a more appropriate risk premium for the financial risk taken. Private credit also addresses shortfalls of the syndicated market through its structure and terms, which better protect lenders in the event of credit stress. As such, we view private credit as the core of a diversified credit allocation today with public credit supporting the allocation on a tactical basis when volatility spikes and select value opportunities arise.

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Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

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Alan Flannigan

Alan Flannigan, CIPM, CAIA

Associate, Investment Research

Christopher Bole

Financial Writer, Fund Communications

Robert Hoffman, CFA

Managing Director, Head of Credit Solutions

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