Next year was supposed to mark a big rebound in corporate bond markets following historic losses. But an end-of-year rally is leaving investors asking how much more they can expect to make.

Risk premiums in European corporate bonds have tumbled to their lowest levels in months after softer US inflation data in November raised hopes of less aggressive central bank policy and spurred a massive relief rally across assets. Last month, the cost of protection against defaults by European blue-chip firms recorded its biggest monthly drop since early 2016, based on data compiled by Bloomberg.

The rebound — which has left an index of European investment-grade debt down 11.6% for the year compared with 16% at its low — came as a chorus of analysts was predicting a strong recovery for the market next year. But the strength of the rally so far is forcing investors to revisit their bullish outlooks.

Long positions in credit “can absolutely become a crowded trade, and we’ve seen some of this happen in recent weeks,” said Brian Kloss, a portfolio manager at Brandywine Global Investment Management. “This risks limiting returns too fast, so you have to be careful about your allocations,” said Kloss, who helps oversee $40.8 billion of fixed income assets.

Even some of the most enthusiastic analysts are now advising caution. UBS Group AG strategists led by Kamil Amin said in a note to clients last week that “credit spreads have rallied too far, too soon.” Last month, they were calling for double-digit euro credit returns that would surpass potential gains from equities in 2023.

UBS said the late-year rally has been driven by high-grade funds neutralizing underweight positions, buyers spending spare cash on new credit issues and strong purchases of exchange-traded funds. Their peers at ING Bank NV attributed spread tightening in junk bonds to “the proverbial fear of missing out on the Fed and market pivots.”

Euro investment-grade spreads were indicated at 174 basis points at Friday’s close, down from 234 basis points in mid-October and near their lowest level since June, according to Bloomberg indexes. Junk bonds and sterling debt have seen similar moves.

“Our impression is that the speed of the rally has taken many investors by surprise, leading them to question whether this move is sustainable,” JPMorgan Chase & Co. strategists led by Matthew Bailey wrote earlier this month.

To be sure, most market participants still expect credit to end 2023 in a better spot. But it may be a bumpy road to get there.

“The entry point will be better in the second half” of 2023, said Martin Hasse, a fixed income analyst and portfolio manager at MM Warburg & Co., which oversees €79 billion ($83 billion). “The market does not price in risks related to recession and we see a widening of spreads in the first half,” he said.

--With assistance from Silas Brown.

This article was provided by Bloomberg News.