Public and private credit: opponents or teammates?

Please note: This article is more technical in nature than our typical articles, and may require some background knowledge and experience in investing to understand the themes that we explore below.

All data referenced in this article are sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.

Key points

• With inflation moderating more slowly, a shallower rate-cutting cycle seems on the cards.
• Bond yields have retreated from January’s highs, but volatility is likely to continue, not least given the additional fiscal-induced supply pressures.
• In the US, a defensive-to-neutral duration approach seems preferable, while diversifying within the bond market remains crucial.
• Private credit is another option for investors. Here, an illiquidity premium means that buy-and-hold investors can find additional return opportunities.

With fewer interest rate cuts now expected in the US this year, what might this mean for credit investors, whether investing in public or private debt markets? 

The major US and European bond markets have faced mixed messages from politicians, central bankers and economic data this year. The strong upward momentum in US yields seen earlier this year, and the end of last, has faded. Yields have retreated from recent highs given growth concerns and softer economic data. Still, uncertainties over the infamous “last mile” for inflation moderation, and uncertainties over debt supply, might result in further volatility in coming months.

Bounce in 10-year bond yields since 2022

The direction of US, French and UK 10-year government bond yields since 2012 

Fed not in a hurry

The US Federal Reserve (Fed) held the policy rate at its February meeting, after having cut rates by one percentage point since their peak in July 2023¹, and reiterated that this may be the beginning of an extended pause in policy easing. 

Commenting on the outlook for US rates, Fed chair Jerome Powell said that the central bank was “in the mode of waiting to see”, and that it does not need to be in a hurry to “adjust our policy stance”. As a result, the market pushed rate cut expectations further out, pencilling in one move at the end of 2025 and two cuts next year. 

The narrative for now points to fewer, rather than more, US rate cuts. A resilient economy, a pause in inflation moderation since summer 2024, and the prospect of a barrage of trade tariffs, remain the main reasons why policy rates are likely to remain restrictive. 

Should inflation remain sticky, the rate market might even price in some probability of a hike, as the next move. While this seems not to be a base case, a shift in pricing dynamics could lead to further volatility in the US rate market. However, over the medium term, US growth might be weaker than anticipated by the rate market. For now, this supports taking a defensive-to-neutral duration stance.

Lower EUR and GBP rates on the horizon

Meanwhile, in the eurozone and the UK, rates have gradually risen again and investors seem to be preparing for fewer cuts in 2025 than had been expected previously. February’s Bank of England (BoE) meeting appeared to be more dovish than had been expected, with the traditionally hawkish member, Catherine Mann, unexpectedly voting for a large half-point cut. 

UK inflation is likely to rebound in the coming months, implying less scope for rate cuts. BoE Chief Economist Huw Pill recently confirmed that, “we cannot declare victory over inflation”.  Still, significantly lower expected trend growth means the likelihood of sustained economic contraction, or a recession, increases. 

While this is may not be an imminent scenario, BoE Governor Andrew Bailey pointed out recently that the economy had been “quite static since late spring last year”. UK rates, therefore, seem to have more downside potential over the medium term. 

Forecast policy rate path

The historical, and forecast, path of UK, eurozone and US rates, as implied by rate markets

Investors turn to private credit 

Public bond markets have been particularly volatile for many months, with little sign of this improving much soon. Meanwhile, some bond investors, in particular those with a buy-and-hold approach, have turned to the private credit market. 

Private credit mostly consists of non-bank lending, typically to middle market companies. While the asset class used to consist of direct lending in the main, it has expanded into other areas of funding, like infrastructure debt. 

The market has more than tripled in size in recent years, outpacing the expansion seen for high yield or loan markets. Private credit assets under management have surged from less than $500 billion in 2012 to over $1.6 trillion in 2024, according to PitchBook, and are expected to reach $2.8 trillion by 2028, according to data researcher Preqin.  

Private trumps public debt?

No, is the answer. Fixed income can provide investors with many benefits, not least aiding portfolio diversification. Indeed, those benefits that most appeal to investors can change, depending on their preferences and on market dynamics. 

The interplay between the dynamics is the key reason why public and private credit can help to diversify portfolios. Private credit, for example, provides an illiquidity premium, which is one of the reasons why the segment has offered higher yields and higher returns, compared to the loan market, historically (although past performance is no indication as to future performance). 

Fresh opportunities 

Many private clients are buy-and-hold investors, that by only holding the more liquid public bonds miss out on the potential return benefits of private markets. 

In addition, private credit provides access to issuers and parts of the fixed income market which otherwise would not be available to them. And with no daily pricing, private debt returns are less prone to market moves than public debt, meaning they can help to reduce overall portfolio volatility. 

Managing the trade-offs

That said, there are trade-offs, including a lack of liquidity, as well as potentially higher credit and idiosyncratic risks. Indeed, in the current environment, liquidity is key to managing portfolios effectively and remains important so as to meet cash flow demands.  

While the spread basis of private credit, compared to public debt, may tighten with increased competition, this can change and is unlikely to be the ultimate driver for flows between the two markets. The crucial exercise for investors is to find the right mix between private and public fixed income portfolio holdings, to optimise the risk and return profile for their specific circumstances and goals.