Preliminary signs of a bubble emerging? U.S. corporate bond spreads hit a record low

According to the Zhitong Finance APP, the spread between U.S. investment-grade and high-yield corporate bonds fell to a historic low last week, a phenomenon that may be seen as an early sign of a bubble emerging. S&P Global Ratings noted in a report on Monday that on November 12, the spread for investment-grade bonds narrowed to 82 basis points (compared to U.S. Treasury yields), while the spread for high-yield bonds narrowed to 214 basis points on November 14.

S&P stated that this change is noteworthy, as U.S. interest rates have been at historically high levels for more than two years due to the Federal Reserve's monetary tightening cycle. "The current spread levels may mask some pressures that companies face regarding actual borrowing costs and debt sustainability," the S&P report pointed out, "This aggressive pricing may also be interpreted as an early sign of a bubble."

Despite the market generally expecting fewer rate cuts in the coming months than previously anticipated, and facing increasing uncertainty, spreads continue to narrow.

Currently, this trend is limited to the United States. While bond spreads globally are generally on a downward trend, spreads in Europe remain above historical lows, primarily affected by the Russia-Ukraine conflict, which has led to an expansion of spreads in that region.

Nevertheless, there are other supporting factors in the credit market, and the narrowing of spreads may not necessarily reflect excessive complacency in the market. U.S. economic growth remains strong, with a real GDP growth rate of 2.8% over the past four quarters. The Atlanta Fed expects the U.S. economic growth rate to be 2.5% in the fourth quarter of this year. Additionally, U.S. corporate earnings have remained positive since 2021 and are expected to continue growing into 2024.

The S&P report noted: "Although corporate bond yields remain at high levels, the relative increase in government benchmark yields has been greater." For example, the yield on BBB-rated corporate bonds rose by 32 basis points, while the yield on B-rated corporate bonds fell by 14 basis points. At the same time, the yield on 10-year U.S. Treasury bonds rose by 58 basis points.

Since the Federal Reserve began its rate hike cycle, the number of corporate ratings upgrades has exceeded the total number of rating adjustments. The report suggests that even if some spread widening occurs in the future, spreads are likely to remain close to historical lows in the short term, making significant widening unlikely.

S&P concluded: "Although the improvement in credit quality supports an optimistic outlook for the bond market, potential increases in tariffs in the future may disrupt the path of declining inflation and interest rates."

As spreads approach historical lows, the development of the bond market will continue to be influenced by U.S. economic growth, corporate earnings, and global geopolitical dynamics