Introduction

Periods of economic uncertainty are very often associated with increased volatility in the financial markets. Investors seeking to protect their portfolios must therefore adapt their strategy in order to minimise losses while seizing available opportunities.

Among the asset classes sensitive to these dynamics, High Yield bonds occupy a particular position. Considered riskier than sovereign bonds from developed countries or stable large companies, they have a lower credit rating and therefore compensate for this increased risk with higher yields.

Table 1: Comparison of yields and sensitivities between market segments as at 1 October 2025

Source: Bloomberg and ICE

At present, this diversification opportunity deserves to be analysed in a context where developed countries' debt faces a growing risk of losing credibility in the long term due to lax fiscal discipline and persistent deficits – the current situation in France illustrating these vulnerabilities.

Sensitivity of High Yield bonds to economic cycles

Historically, High Yield bonds, whether issued by sovereigns or corporates, tend to react significantly to macroeconomic developments. As a result, they can offer attractive buying opportunities when a spread widening reflects a general macroeconomic shock rather than an actual deterioration in their results. For example, the announcement of tariffs by the US administration led to a widening of spreads across the entire High Yield market, even though not all of the companies concerned were directly affected by these measures.  

Change in the global economic uncertainty index and high yield spreads 
 
Source: Bloomberg

As such, Sovereign bonds issued mainly by emerging economies are particularly exposed to global economic shocks and geopolitical turmoil. The more cyclical nature of their economies, which are often concentrated in a limited number of sectors, makes them more vulnerable to these shocks than developed economies. Due to their lower economic diversification, a shock affecting a key activity can rapidly cause major imbalances and lead to widespread economic instability. As a result, markets require higher yields on these countries' debt, limiting their refinancing capacity. This vicious circle has repeatedly led to economies being forced into restructuring. In this type of environment, risk aversion increases and investors tend to shift towards developed sovereign debt, which is considered less risky in terms of default.

However, it should be noted that economic shocks often lead to indiscriminate widening of spreads, even though not all countries are affected in the same way. Once the slowdown is over, spreads tend to narrow rapidly, offering attractive buying opportunities for investors with a long-term view and a selective approach.

Corporate bonds also come under considerable pressure during economic downturns. Companies see their financing costs rise and their access to markets reduced. Logically, those with fragile balance sheets or significant refinancing needs are the first to pay the price in these restrictive environments.

For example, during the 2008 financial crisis, High Yield bonds fell significantly, dropping 30%, while the Covid-19 crisis in 2020 caused a 20% decline. These periods show how sensitive High Yield bonds (and even, in some cases, Investment-Grade bonds) can be to economic cycles, even if losses remain latent as long as issuers do not default.

Opportunities and risks for High Yield government bonds...

High Yield sovereign issuers offer attractive investment opportunities, particularly those countries whose governance is focused on economic diversification and reducing their dependence on traditional exports, enabling them to better withstand fluctuations from their foreign trading partners. Costa Rica, for example, offers attractive prospects thanks to its economic reforms and prudent management of public finances.

Eastern European nations, meanwhile, are benefiting from their geographical proximity to developed European markets and their efforts to diversify their economies. Some countries stand out for their ability to attract foreign direct investment, supporting their economic growth even during periods of slowdown.

However, challenges remain. Political instability and vulnerability to external shocks, such as a sudden rise in interest rates or a geopolitical crisis, remain major risks for these issuers. The inflationary crisis of 2021-2022 illustrated the difficulty some economies have in maintaining economic stability in the face of adverse global conditions.

... and for High Yield corporate bonds

High Yield corporate bonds, although less exposed to currency fluctuations, are not risk-free in times of economic uncertainty. While defensive sectors such as Healthcare, Utilities and Food are more resilient and generally hold up better, companies in cyclical sectors such as Consumer Discretionary are often the hardest hit during economic downturns. In the financial markets, this is reflected in a widening of spreads relative to risk-free rates.

The volatility of High Yield corporate bonds in times of crisis is often marked by significant spread widening, but also by rapid rebounds once economic conditions stabilise. For example, after the 2008 financial crisis, the BB-B rated European bond index recovered to its previous level in just six months. This ability to rebound highlights the importance of active management and careful issuer selection in order to seize opportunities when prices are depressed.

Despite these periods of volatility, High Yield corporate bonds have posted an annualised return of 5.6% over 20 years, slightly lower than that of the MSCI Europe equity index, which stands at 7.1%. Furthermore, these bonds remain significantly less volatile than European equities, with volatility of 4.78% compared to 18.20% for the European stock index¹.

Performance of a European equity index vs. a High Yield Euro bond index and an Investment Grade bond index

 
Source: Bloomberg

Risk analysis, selectivity and diversification

Given the complexity of this asset class, linked in particular to its higher volatility and increased default risk, it is essential to address it with a rigorous risk analysis approach and a high degree of selectivity. Investors must closely monitor macroeconomic and microeconomic fundamentals as well as idiosyncratic indicators. The key role played by diversification should not be overlooked either: by spreading investments across different regions and sectors, it is possible to mitigate the risks associated with volatility and default.

Conclusion: A resilient asset class full of opportunities

In an uncertain economic climate, adding High Yield bonds, whether Sovereign or Corporate, to their portfolios has proven to be a wise move for investors seeking attractive returns. Although these securities are riskier and more volatile, they offer significant upside potential when the economic outlook improves.

However, until proven otherwise, developed country government debt remains a safe haven in times of economic downturn, even if it is no longer entirely free of long-term concerns.

Thus, in an environment where the sustainability of developed economies' public debt is raising more and more concerns, High Yield bonds, which combine attractive yields and potential for recovery, are a relevant diversification option, provided they are subject to rigorous analysis given the increased risk involved.

¹ Source: Bloomberg, data from 03/01/2006 to 09/09/2025 in EUR.

Written by Jean-Albert Carnevali, Fixed Income Fund Manager and Maxime Smekens, Fixed Income Analyst

BLI - Banque de Luxembourg Investments, a management company approved by the Luxembourg Financial Sector Supervisory Commission (CSSF).

Final drafting date: 7 October 2025

Publication date: 13 October 2025 at 14:10

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