RiskBridge believes in the market adage that credit markets lead the stock market, usually with a 9-12 month lead time. Credit spreads are, in our view, the “canary in the coal mine” to determine if slowing nominal GDP growth is challenging free cash flow for corporate bond and equity investors.
We share the following chart and commentary from Jessica Rabe and Nick Colas at DataTrek, to which RiskBridge subscribes.
The following chart shows Investment Grade (black line, left axis) and High Yield (red line, right axis) spreads from 2021 to the present:
US corporate bond spreads are finally exhibiting some concern about the US economy. As a reminder, the difference between the yield on a corporate bond and a Treasury of similar duration is called the “spread.” These tend to rise when the corporate bond market is growing worried about a US recession and decline when those concerns abate.
Three comments on this data:
- The correlation between spreads and stock market direction is clear. The equity bull markets in 2021 and 2023 to date saw spreads generally decline, whereas the 2022 bear market exhibited both sharp increases in spreads and significant volatility throughout the year in this measure of corporate bond investor confidence.
- Spreads are usually sticky during stock bull markets, only moving higher quickly when there is a clear catalyst that creates market concern. The chart highlights 3 such events in 2023 and 2024: the failure of Silicon Valley Bank in March 2023, the surprise move in 10-year Treasury yields to almost 5 percent in October 2023, and the sudden volatility in the yen and Nikkei in August 2024.
- Last week’s move higher in spreads (+8 basis points for IG, +43 bp for HY) are not as sharp as those during the yen/Nikkei shock (IG +16 bp, HY +73 bp). Back then, markets were concerned that the “yen carry trade” would unwind and cause a steep correction. As much as spreads increased last week, they did not move as much as in this prior instance.
Takeaway: The US corporate bond market now reflects some of the same concerns that have been roiling stocks, but current levels and last week’s move suggest only a modest repricing of recession risk. This risk-averse market is particularly good at reacting well ahead of economic downturns (e.g., 2022), and, thus far, it remains quite confident in the future of the US economy.
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