A flood of capital into private credit has dramatically increased competition, causing the yield spread over public markets to shrink from 3-4% to less than 1%. This compression raises serious questions about whether investors are still being adequately compensated for illiquidity risk.

Default rates are not uniform. High-yield bonds are low due to a 2020 "cleansing." Leveraged loans show elevated defaults due to higher rates. Private credit defaults are masked but may be as high as 6%, indicated by "bad PIK" amendments, suggesting hidden stress.

A consistent 2-5% of Europe's public high-yield market restructures annually. The conspicuous absence of a parallel event in private markets, which often finance similar companies, suggests that opacity and mark-to-model valuations may be concealing significant, unacknowledged credit risk in private portfolios.

Counterintuitively, high-yield corporate bonds are expected to perform better than investment-grade credit. They do not face the same supply headwind from AI-related debt issuance, and their fundamentals are supported by credit team forecasts of declining default rates over the next 12 months.

Credit spreads are becoming an unreliable economic signal. The shift of issuance to private markets reduces the public supply, while the Federal Reserve's 2020 intervention in corporate debt markets permanently altered how investors price default probability.

The high-yield market's credit quality is at an all-time high, not due to broad economic strength, but because of a massive influx of 'fallen angels.' Downgrades of large, formerly investment-grade companies like Ford and Kraft Heinz have structurally improved the overall quality of the index.

The modern high-yield market is structurally different from its past. It's now composed of higher-quality issuers and has a shorter duration profile. While this limits potential upside returns compared to historical cycles, it also provides a cushion, capping the potential downside risk for investors.

The gap between high-yield and investment-grade credit is shrinking. The average high-yield rating is now BB, while investment-grade is BBB—the closest they've ever been. This fundamental convergence in quality helps explain why the yield spread between the two asset classes is also at a historical low, reflecting market efficiency rather than just irrational exuberance.

The massive growth of private credit to $1.75 trillion has created an alternative financing source that helps companies avoid default. This liquidity allows them to restructure and later refinance in public markets at lower rates, effectively pushing out the traditional default cycle.