Solid Ground, Shifting Winds: Navigating a Nuanced Credit Market

Matt Freund, CFA, Christian Brobst, and Chuck Carmody, CFA

Summary Points:

We believe:

• Fiscal tailwinds from the One Big Beautiful Bill Act (OBBBA) should sustain US economic momentum into 2026.
• Corporate credit fundamentals remain solid; defaults are well below long-term averages, and the technical backdrop is supportive
• Ongoing easing, large fiscal deficits, and inflation uncertainty should continue driving the yield curve steeper, supporting our defensive positioning which includes an emphasis on higher credit quality.

2025 was a year of notable change. The Trump administration returned to an economy with 3% inflation and softening growth, and the tension in the Fed’s dual mandate led it to be on “hold” pending clarity on the administration’s new fiscal initiatives, mainly tariffs and landmark tax legislation. By the fall, “better than feared” outcomes allowed the Fed to resume cutting overnight rates. Ten-year rates responded by trading up to 4.8% in January, before settling below 4.2% by year-end. At the same time, economic growth defied expectations and accelerated as 2025 progressed.

The Fed’s policy is approaching what it has long held as the neutral rate of interest (around 3%). We believe that’s appropriate, given that inflation and unemployment are both heading gradually in the wrong direction. However, the labor market may be stronger than headlines suggest. With immigration enforcement contributing to suppressed labor supply, approximately 50,000 jobs created per month may be enough to maintain a stable unemployment rate. This compares to the 250,000‒300,000 run-rate once needed.

Politicians, consumers, and investors all have slightly different reasons for wanting lower interest rates, and the incoming Fed chair will undoubtedly lean dovish. Nonetheless, the OBBBA is poised to provide material fiscal support to both households and businesses. This strong fiscal tailwind could slow the progress of further rate cuts, especially if affordability remains problematic or long-term rates rise. We believe true consumer weakness—e.g., from a weakening labor market or declining equity market—will be needed to justify rates substantially below neutral.

Corporate credit fundamentals remain solid in both the investment-grade and high-yield markets. Trailing 12-month defaults are significantly below the long-term average. After reaching a post-Covid low of 3.9x in early 2023, market leverage climbed back to 4.4x and is just above the 25-year average. Interest coverage, which had been declining in the face of increasing interest costs, appears to have leveled off at a healthy 4.2x. While we expect default rates to increase modestly in 2026, they remain well below long-term averages.

The technical backdrop for corporate debt markets remained strong throughout 2025. High-yield issuance rose sharply to $331 billion in 2025, a 15% increase year-over-year. Net issuance grew even more substantially; $976 billion in new leveraged loans was lower than the 2024 total, but net issuance of $169 billion (+17% year-over-year) significantly exceeded expectations. Anecdotally, we continue to see strong demand for deals in the market despite the increase in supply. High-yield bond and leveraged loan funds had another year of solid inflows. Additionally, rising stars continued to outpace fallen angels in 2025.

Despite the solid backdrop, several areas face structural headwinds. Among them, the chemical and paper-and-packaging industries include several stressed and distressed companies struggling with operational challenges such as elevated raw material costs, excess capacity, and increased international competition. However, we do not anticipate widespread weakness, as hard consumer data shows resilience despite the weakest consumer confidence survey results in years. The combination of healthy albeit gradually deteriorating fundamentals and a strong technical backdrop has kept credit spreads low and in a tight range throughout the year. We anticipate this environment to continue well into 2026. The next 50-basis-point move in high-yield spreads is likely wider, but tight trading environments can persist for years before material widening occurs.

We expect record investment grade debt supply in 2026 as technology firms borrow to build out digital infrastructure. Some market estimates reach as high as $2.25 trillion. This is an immense number, several hundred billion ahead of this year’s record $1.65 trillion pace. Spreads in tech industries may face headwinds as a result, but are unlikely to be based on fundamental balance sheet risks. (Consider that AI hyperscalers can issue $700 billion of additional debt without raising their collective leverage measure above 1x.)

Positioning Implications

The Fed faces an unusual challenge: Both sides of its dual mandate are under stress simultaneously. These circumstances clearly increase the chances of a policy error (at least in hindsight). Even so, the ongoing easing cycle and questions about Fed independence—coupled with large fiscal deficits and persistent inflation uncertainty—should continue driving the yield curve steeper.

We have positioned Calamos Short-Term Bond Fund with a duration longer than its benchmark, while Calamos Total Return Bond Fund’s duration is just short of its benchmark, with the underweight focused on exposure to 30-year rates. For Calamos High Income Opportunities Fund, where interest-rate sensitivity has a lower impact on returns, we have positioned the fund with a duration short of its benchmark.

Technical tailwinds should constrain credit spreads to narrow ranges in the near term. Spread compression across the rating spectrum has presented a tactical window to maintain an up-in-quality bias while largely preserving their income characteristics. Our defensive positioning will persist until the relative value in lower-tier credits improves sufficiently to merit taking on increased risk.