Goldman Sachs: Rising Stars in USD Credit Market Upgraded, Fallen Angel Risks Intensify in EUR

Overview

This report provides Goldman Sachs’ fixed income credit strategy outlook, focusing on 'crossover' dynamics between investment grade and high yield bonds in USD and EUR markets, with particular attention to trends in fallen angels (downgrades from investment grade to high yield) and rising stars (upgrades from high yield to investment grade). The report notes that while both USD and EUR markets exhibit a 'flight-to-quality' dynamic—where BB-rated bonds consistently outperform B-rated bonds—significant divergence exists between the two markets in terms of rating migration, technical pressures, and fallen angel risks. The USD market benefits from a higher volume of rising stars, whereas the EUR market faces greater supply pressure from fallen angels, marking the first year since 2020 where fallen angels will exceed rising stars in EUR.

Core views

Risk-off sentiment within high yield: In both USD and EUR markets, BB-rated bond spreads continue to outperform single-B rated bonds, with B/BB spread ratios near historical highs. This reflects a 'risk-off' allocation bias within the high yield segment, despite broader risk-on sentiment at the index level. However, this risk-off behavior has not fully extended to crossover trades between lower-tier investment grade (BBB) and upper-tier high yield (BB), as BB/BBB ratios in both markets remain near historical lows. Divergence between USD and EUR markets: BB/BBB ratios in the USD market appear fairly valued and are expected to trade range-bound around current levels, primarily challenged by growth and inflation dynamics. In contrast, the EUR market shows more room for spread compression due to weaker growth prospects (persistent energy shocks) and higher technical pressures on BB-rated bonds stemming from fallen angel risks. Revised rating migration forecasts: The report introduces a new framework based on historical rating transition behavior to model fallen angel and rising star risks, adjusted with a subjective overlay. Under this framework, the USD 2026 rising stars forecast is upgraded from $40 billion to $75 billion (the model implies ~$85 billion, but this is moderately reduced due to anticipated growth and inflation headwinds). The USD fallen angels forecast remains at $60 billion. For EUR, rising stars and fallen angels are forecast at €20 billion and €30 billion respectively, meaning EUR will experience more fallen angels than rising stars for the first time since 2020. Divergent post-downgrade performance: In the USD market, fallen angels typically outperform after downgrade because downgrades are usually well-telegraphed, and subsequent inclusion in high yield indices expands the buyer base. In EUR, however, fallen angels tend to underperform post-downgrade, partly due to a higher proportion of single-rated issuers (19% of nominal amount in EUR BBB market vs. <1% in USD), making downgrade risks more abrupt and harder to price in advance. Additionally, downside outcomes are more severe in EUR: since 2010, 5% of EUR fallen angels were downgraded to CCC+ or lower within one year, compared to 1.5% in USD. Sector drivers: The wave of EUR rising stars since 2021 has been concentrated in European financials (banks account for 30% of rising stars), but the banking sector faces headwinds from higher taxation, slowing growth, and sovereign fiscal risks in certain countries, which may limit further upgrade momentum. USD rising stars are more diversified across sectors such as energy, autos, and TMT. Current energy shocks exert greater pressure on energy-intensive and rate-sensitive sectors, which constitute a larger share of BBB/BBB- rated bonds in EUR (autos, chemicals, REITs, food & beverage account for 24% of EUR BBB/BBB- issuers under negative outlook or downgrade watch, versus 16% in USD). Specific issuer-level fallen angel risks exist in both markets—concentrated in banks in EUR and in software in USD.

Analysis framework

The report employs a historical rating transition analysis framework, calculating the probability over the past year that bonds in specific rating buckets became fallen angels or rising stars. BBB- bonds under negative outlook or downgrade watch show the highest propensity to become fallen angels, while BB+ credits under positive outlook or upgrade watch show the highest likelihood of upgrading back to investment grade. However, the report emphasizes that ratings and outlooks are at best imperfect forward indicators: since 2010, roughly half of all fallen angels in both markets came from issuers without prior explicit downgrade signals (i.e., no negative outlook or downgrade watch). This 'surprise' dynamic is even more pronounced when tracking rising stars. Therefore, the report overlays subjective judgment on top of historical transition behavior—for example, the USD rising stars model implies ~$85 billion, but the official forecast is adjusted to $75 billion considering anticipated challenges from the growth and inflation backdrop. The report also assesses how well the market prices fallen angel risk by comparing the proportion of BBB- bonds trading wider than average BB+ bonds. It finds this proportion is approximately 2% in EUR and 15% in USD—both near decade lows—suggesting the market is not fully pricing in significant fallen angel risks.

Methodology notes

• Fixed Income & Credit AnalysisSpreads and Asset Quality

  Modeling fallen angel and rising star risk using historical transition probabilities by rating bucket

  The report calculates historical probabilities of downgrade or upgrade within one year for different rating categories (e.g., BBB-, BB+, etc.) to forecast future rating migration volumes. This helps investors quantify potential supply shocks from credit quality changes, though it notes that about half of fallen angels originate from issuers without prior explicit downgrade signals.

• Fixed Income & Credit Analysis

  Impact of single-rating-agency coverage on downgrade predictability

  The proportion of single-rated issuers is significantly higher in Europe than in the US (19% in EUR BBB market vs. <1% in USD), making EUR fallen angel risks more abrupt and harder for markets to anticipate in advance. This is a key structural factor in understanding cross-regional credit risk differences.

• Industry/Sector Analysis FrameworkSupply-demand framework

  Technical supply impact of fallen angels and rising stars on credit markets

  Fallen angels increase high yield market supply (flowing in from investment grade), potentially pressuring lower-rated bond prices; rising stars reduce high yield supply (flowing out to investment grade), potentially supporting high yield prices. The report evaluates net flows to assess technical pressures across markets.

• Fixed Income & Credit Analysis

  Performance analysis of fallen angels before and after downgrade

  The report compares the relative performance of fallen angels in USD and EUR around downgrade events against investment grade and high yield indices. It finds USD fallen angels typically outperform post-downgrade (due to well-telegraphed downgrades and HY index inclusion expanding the buyer base), while EUR fallen angels underperform (due to single-rating structures causing more abrupt risk realization). This informs cross-market allocation decisions.

• Event Arbitrage & Behavioral FinanceExpectation Gap / Expectation Management

  Assessing market pricing of fallen angel risk

  By comparing the proportion of BBB- bonds trading wider than average BB+ bonds, the report evaluates whether markets have adequately priced fallen angel risk. Currently, this proportion is ~2% in EUR and ~15% in USD—both near decade lows—indicating insufficient pricing of significant fallen angel risk and potential expectation gaps.

• Industry/Sector Analysis Framework

  Link between sector concentration and rating migration risk

  The report identifies the share of issuers under negative outlook or downgrade watch by sector, finding energy-intensive industries (autos, chemicals, REITs, food & beverage) account for 24% of EUR BBB/BBB- issuers under negative watch versus 16% in USD; in USD, the software sector faces specific fallen angel risks. This helps investors pinpoint sector-level credit exposures.

Key data

• USD 2026 Rising Stars Forecast$75 billionUpgraded from previous $40 billion; model implies ~$85 billion but adjusted downward due to growth and inflation headwinds
• USD 2026 Fallen Angels Forecast$60 billionUnchanged from prior forecast
• EUR 2026 Rising Stars Forecast€20 billionUnchanged from prior forecast
• EUR 2026 Fallen Angels Forecast€30 billionUnchanged; will be the first year since 2020 with more fallen angels than rising stars
• Share of Single-Rated Issuers in EUR BBB Market19%Less than 1% in USD; leads to more abrupt downgrade risks in EUR
• Share of Fallen Angels Downgraded to CCC+ or Lower Within One Year (EUR)5%Since 2010; 1.5% in USD
• Share of Energy-Intensive Sectors Among EUR BBB/BBB- Issuers Under Negative Outlook24%Includes autos, chemicals, REITs, food & beverage; 16% in USD
• Bank Share of EUR Rising Stars (Since 2021)30%But faces headwinds from higher taxes, slowing growth, and sovereign fiscal risks
• Proportion of BBB- Bonds Trading Wider Than Avg. BB+ (EUR)~2%Near decade low, indicating insufficient pricing of fallen angel risk
• Proportion of BBB- Bonds Trading Wider Than Avg. BB+ (USD)~15%Near decade low

Impact & implications

The report argues that the divergence between USD and EUR credit markets has important implications for investor allocation. The USD market, with more rising stars and less fallen angel pressure, offers relatively favorable technicals for high yield; the EUR market faces technical headwinds from increased fallen angel supply, which could weigh on BB-rated bond performance. In relative value recommendations, the report suggests overweighting USD vs. EUR, overweighting investment grade vs. high yield in USD, overweighting BBB vs. higher ratings, and overweighting BB while underweighting single-B. In EUR, it recommends overweighting investment grade vs. high yield, overweighting A-rated vs. BBB (due to weaker growth requiring higher quality), and overweighting BB while underweighting CCC. Additionally, the report highlights that fallen angel risks are underpriced in current spreads—particularly in EUR—and investors should consider this unpriced risk.

Risks

• Macroeconomic shocks could deteriorate fundamentals faster than rating agencies adjust, increasing uncertainty in fallen angel forecasts
• Single-rating structure in EUR may cause downgrade risks to materialize more abruptly, limiting investor preparedness
• Persistent energy shocks in Europe could further erode credit quality in energy-intensive sectors
• Banks face higher taxation, slowing growth, and sovereign fiscal risks, potentially capping further EUR rising star momentum
• Software sector in USD faces issuer-specific fallen angel risks

What to watch

• Actual vs. forecasted flows of fallen angels and rising stars in USD and EUR markets
• Rating actions in EUR energy-intensive sectors (autos, chemicals, REITs, food & beverage)
• Credit quality developments in the USD software sector
• Changes in the proportion of BBB- bonds trading wider than average BB+ bonds, as a gauge of fallen angel risk pricing
• Trends in single-rating issuer prevalence in Europe and potential regulatory shifts