European HY spread widening has been targeted and orderly
European high yield (HY) credit, which had proved resilient to start 2026 despite growing concerns over AI risks, came under pressure in March as the Iran war disrupted global trade and weighed heavily on risk appetite. Yields sold off gradually throughout the month, which resulted in a negative total return for the European HY index of -2.7% in March.
The sell-off was driven by a repricing of both rates and spreads. Investors adjusted central bank policy expectations to factor in the prospect of rate hikes, in light of higher oil prices, and credit risk against the more challenging macroeconomic backdrop.
We saw a high level of dispersion between individual names, as investors reduced exposure to the more vulnerable parts of the asset class. Spreads for riskier single-B rated credits widened materially, as the grouping average increased more than 100bp at the peak of the sell-off. Investors sought higher quality credit, with BBs more resilient than single-Bs having traded around 50bp wider at the peak (see Exhibit 1).
Sector performance also varied significantly. Energy intensive sectors such as Construction, Metals & Mining were among the worst performers. They were joined by Transportation and Paper & Packaging, both highly exposed to global supply chain shocks and trade flow disruption from the effective closure of the Strait of Hormuz. Real Estate also neared the bottom of the pack as fears of an inflationary spiral and potential rate hikes rekindled memories of 2022, when the sector sold off sharply as property prices came under pressure.
By contrast, Energy was unsurprisingly the best performer, along with the typically more defensive sectors, such as Tech, Media & Cable and Utilities, which also benefit from a high concentration of stronger balance sheets. The performance of the long-suffering Chemicals sector was roughly neutral, partly because the sell-offs of 2025 had been so pronounced and partly due to the prospect that higher oil prices could support margins for European commodity chemical producers, allowing them to pass through price increases, while also reducing the competition from Asian imports.
Overall, the dispersion in returns underlines that despite the volatile geopolitical backdrop, the market reaction has been relatively targeted. Investors have focused on avoiding specific conflict-related risks, rather than engaging in broad-based selling. This has been supported by positioning among European asset managers, which remains more defensive than historical norms. Sentiment has also improved since news of negotiations between the US and Iran. BB rated spreads are now close to pre-war levels and single-Bs only around 50bp wider, signalling continued confidence in the fundamental picture and a willingness to look through the conflict.
We also had the opportunity to validate this view from a bottom up perspective at a European leveraged finance conference last week. The event was well attended, and we heard directly from HY issuers and other market participants on how they are navigating the conflict. The tone from management teams was broadly constructive, with no evidence of panic around potential disruption in the Strait of Hormuz escalating into near term demand destruction. Several issuers highlighted measures in place to mitigate energy risks, with a high proportion of energy costs for 2026 and 2027 already hedged. This suggests a sharper focus on energy security in response to the Russia Ukraine war has helped their positioning for this conflict.
Looking ahead, we nonetheless retain our preference for higher quality credit and note our direct exposure to the key pressure points remains very limited. We remain constructive on credit overall, taking comfort in the downside protection offered by a portfolio of higher quality assets at compelling yields; however we recognise that active portfolio management remains vital in such a fast-moving environment.
