Alternative credit outlook: from near-term volatility to medium-term regime risk
We are entering a higher-uncertainty macroeconomic environment. Geopolitical tensions, tightening energy supply, and restrictive monetary policy increase the risk that inflation remains elevated longer than previously anticipated. The Middle East conflict has evolved from a temporary volatility shock into a structural component of risk pricing. This shift raises the probability of sustained higher policy rates across the US, UK, and Europe.
For alternative credit, the primary challenge is repricing risk. Private credit, leveraged loans, and structured credit have thrived under benign conditions — normalising inflation, strong earnings, and low defaults. A transition to higher and more volatile rates will test valuations, refinancing channels, and underwriting assumptions, even if near-term defaults remain manageable.
Macro scenarios: base case and tail risks
Our Research and Macroeconomics team evaluates scenarios ranging from rapid de-escalation to prolonged energy disruption. For credit investors, the most relevant case is "managed disruption": partial recovery in oil and gas flows with persistent instability keeping energy risk premia elevated. Under this scenario, Brent crude averages around $80 per barrel in 2026, stabilising near that level in 2027.
In the adverse tail scenario, energy flows remain constrained significantly longer, extending inflation pressures and keeping oil prices elevated until at least Q3 2026, with only gradual normalisation thereafter. While not our base case, this scenario is critical for stress testing and assessing how much tail risk is embedded in current credit spreads.
Across all scenarios, one conclusion stands firm: inflation persistence remains a material risk, implying an extended period of restrictive policy and higher term premia than pre-pandemic levels.
While central banks remain data-dependent, market pricing has moved toward a higher-for-longer distribution. The transmission channel is familiar: energy and freight costs can re-accelerate headline inflation and, if sustained, bleed into broader price-setting behaviour.
Credit conditions: fundamentals stable, dispersion rising
Broader credit fundamentals remain constructive. Default rates in public leveraged loans and private credit are contained, and many issuers entered this phase with adequate liquidity and manageable near-term maturities. Household balance sheets appear broadly resilient in aggregate across the US and Europe, though this resilience varies significantly by income cohort and product type.
However, dispersion is widening. In private credit, stress is increasingly idiosyncratic and deal-specific, with selective defaults and liability-management activity occurring at higher levels than in 2023, though trending downward since last year. This reflects tighter underwriting, more active sponsor-lender negotiations, and heightened focus on covenant packages and documentation quality.
Consumer credit also shows bifurcation: mortgage delinquencies remain low, while stress is building in auto and credit card portfolios — particularly in subprime segments. This is a classic late-cycle pattern, where higher rates first compress affordability in revolving and shorter-duration products.
Software and AI: underwriting assumptions shift
A structural theme reshaping alternative credit is the repricing of technology and software cash flows. Since mid-2025, markets have increasingly weighted AI-driven disruption risk, elevated reinvestment requirements (capex), and intensifying competitive pressures. This has triggered broad derating across technology credit in both equities and credit markets.
While AI offers productivity gains, it also threatens to compress demand and pricing power in certain software categories. Historically, software companies enjoyed high margins and strong monetisation. The proliferation of generative AI tools — particularly those accelerating coding and automating software development — raises questions about long-term competitive advantages and pricing durability in certain segments.
This directly impacts leveraged loans and private credit. Software-linked leveraged loans have repriced substantially, and private credit strategies with higher technology exposure have experienced valuation pressure. Nevertheless, software defaults remain among the sector's lowest, with zero defaults recorded in private credit software exposures during 2025 according to Fitch. In the US, the sector also continues to generate higher profit margins than the wider Tech sector.
The critical underwriting question is whether a software issuer possesses durable competitive advantages or faces commoditisation. Mission-critical, specialised ("vertical") software — embedded in regulated or workflow-intensive environments — typically exhibits higher switching costs and stronger data advantages. General-purpose ("horizontal") software with lower switching barriers faces greater exposure to AI-driven substitution. This distinction is now central to underwriting, covenant calibration, and loss-given-default assessments.
BDCs: vehicle structure and liquidity transmission
Recent stress in Business Development Companies (BDCs) reveals a critical dimension for private credit investors: the interaction between public-market price discovery and private-market NAV valuations. BDCs, which lend to mid-market companies, have experienced significant valuation pressure since mid-2025, with further declines in 2026.
Sector concentration, particularly in technology, has been a primary driver of stress in some vehicles, with technology exposure reaching nearly 30% of portfolio assets in certain cases. As listed BDC discounts widened, this pressure cascaded to non-listed vehicles through elevated redemption requests, demonstrating how NAV-based structures can amplify downturns when investor sentiment deteriorates.
Manager performance has diverged considerably. More diversified portfolios with stronger underwriting have weathered the downturn better, while concentrated and/or less transparent portfolios have experienced sharper repricing. For institutional allocators, the key insight is that fund terms, liquidity provisions, gating mechanisms, and valuation policies, can be as consequential as asset-level credit quality when risk appetite resets.
Relative value: US vs. European private credit
The choice between US and European private credit opportunities remains a pivotal allocation decision. Europe has historically demonstrated more defensive and less cyclical characteristics. European leveraged loans typically exhibit lower default rates than their US counterparts, supported by more conservative underwriting standards, stronger collateral packages, and lower leverage ratios.
This disciplined approach is reinforced by regulatory frameworks and legal complexity, which create barriers to entry and constrain excessive risk-taking. Although leverage levels are typically lower, spreads remain attractive, delivering competitive risk-adjusted returns within a more conservative framework.
European and US markets also differ in sector composition. Europe maintains lower concentration in technology and software, reducing vulnerability to sector-specific downturns. The European private credit market, while smaller, has expanded substantially over the past 15 years and remains relatively underpenetrated, offering significant room for continued growth. In contrast, the US market is deeper and more mature, though underwriting standards have appeared to loosen in recent years.
Credit cycle outlook: orderly repricing vs. downturn risk
The near-term trajectory hinges on the balance between orderly repricing and material downturn. Current evidence supports controlled repricing: corporate earnings remain resilient, defaults are contained, and household balance sheets are broadly healthy. However, the distribution of outcomes is increasingly sensitive to energy prices and geopolitical developments.
We are closely monitoring three critical transmission channels:
- Second-round inflation effects: Whether elevated input costs become embedded in broader pricing and wage dynamics.
- Confidence and demand: Whether real-income pressure triggers consumption and capex contraction (often signalled early by PMIs and consumer confidence indices).
- Sector spillovers: Particularly affecting energy-intensive industries and global supply chains.
If these channels remain contained, we anticipate an orderly credit cycle characterised by wider dispersion and selective capital deployment. If they intensify, risks shift toward a broader, demand-led slowdown. From a portfolio perspective, this environment demands emphasis on seniority, robust covenant protection, downside scenario analysis in underwriting, and rigorous manager selection.
Conclusion: higher volatility, greater dispersion
Alternative credit is entering a regime where macro-driven repricing and volatility pose greater risks than near-term default spikes. Geopolitical uncertainty, structurally elevated energy prices, and persistent inflation imply a higher cost of capital and wider valuation outcomes for credit.
Fundamentals provide meaningful support: corporate earnings remain solid, AI-related investment continues, and household balance sheets are broadly healthy. This mitigates the risk of a classic credit downturn. Instead, returns will likely be determined by underwriting discipline, sector selection, and deal structure (seniority, covenants, and documentation quality) rather than broad beta exposure.
In this environment, performance will increasingly differentiate across managers, sectors, and individual credits. A disciplined investment process, encompassing scenario analysis, downside underwriting, and careful assessment of vehicle terms, should become a primary driver of both returns and risk management.
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Due to its simplification, this insight is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
Edited by BNP PARIBAS ASSET MANAGEMENT Europe, a company incorporated under the laws of France, having its registered office located at 1 boulevard Haussmann - 75009 Paris, registered with the Paris Trade and Companies Register under number 319 378 832, and a Portfolio Management Company, holder of AMF approval no. GP 96002, issued on 19 April 1996.
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