UBS Equities-Global Strategy _How complacent are global credit markets_ ...-117041438

ab4 August 2025Global ResearchGlobal StrategyHow complacent are global credit markets?Summary: some signs of complacency, more so in US than in EuropeCredit complacency is a dominant theme across our investor meetings. This report analyzes the complacency of US and European credit markets across various key indicators, including fundamental, technical, and valuation. In the US there are more signs of complacency as spreads imply higher growth rates than other asset classes, cross asset correlations are high, and positioning also looks stretched - particularly in high yield and loan funds. In comparison, European credit markets show some sign of exhuberance around global growth expectations and in subordinated financials given tight spreads vs. peers, but also exhibit healthier signals in cross asset correlations, inflation risks, and the pricing of default risk. Overall, both markets display a mix of optimism and underlying risks that could lead to potential vulnerabilities, but the US looks more complacent. Ahead of a stagflationary mix of data and low dealer risk appetite we're sticking with a view for moderate Q3 widening in US IG/HY spreads with a peak near ~100/ 375bp (vs. 80/ 301bp spot), but we'd be more disposed to 'buy the dip' into year-end.1. Global growth: credit spreads look complacent to downside risksImplied global growth rates across asset classes suggest that many risk assets are pricing in a higher growth outlook than we expect. However, credit markets are outliers, with market-implied growth from EU and US HY credit spreads in the high 4% and low 5% range, respectively. This is above the average for other asset classes and above UBS's full-year global growth forecast of just below 3% (Fig 1).2. Cross-asset correlations: US credit more vulnerable in a sell offCorrelations between US credit markets, equities, and interest rates are above average at 65%, indicative of less diversification benefit and increased risk in a broad market sell-off. In Europe, correlations across major asset classes are near average at 30%, suggesting better support (Figs 2-4).3. Labor market health: July NFP was weak, more softness aheadThe July US nonfarm payroll report was a weak report, and US Q2 GDP showed signs of deceleration relative to Europe. So far other indicators have been more mixed; e.g., the UBS consumer credit cycle health gauge is showing sequential improvement, led by a bit better consumer sentiment and resilient auto sales data in July. But our economists expect further softness with negative payrolls (-12k) and an unemployment rate of 4.6% in Q425. Historically, US credit have been resilient to temporary labor market weakness, but more recent examples from 2007, 2008, and 2011 suggest IG/HY spreads can widen about 15-20/ 60-75bp (Figs 5, 6).4. Inflation outlook: US/EU diverging, risks to US as core rises above 3%There is a clear divergence between the US and Europe in market-based inflation expectations. The US is expect