22 Aug 2025
Author | Alexander Pelteshki, CFA, Portfolio Manager
Credit markets are flashing a signal that hasn’t appeared in decades: corporate bonds are trading as if default risk has virtually disappeared. This compression in credit spreads – the extra yield investors demand to hold corporate debt over government bonds – has created either an extraordinary opportunity or a dangerous trap.
Global credit spreads have reached generationally tight levels. US investment grade credit spreads are trading in the high 70s – near decade lows. The picture is very similar across developed markets, with European Investment Grade credit making new tights almost daily this summer.
There is very little risk premium built into high yield either. Looking at credit spreads alone, the market has not been so complacent about corporate default risk in a very long time. The creditworthiness of corporate issuers appears fairly priced in current compensation for default risk.
The driving forces
We are not negative on the market here. The driving forces behind spread compression are very strong – US annuity sales hit an all-time high in 2Q25, investment grade mutual fund flows reached a 4-year peak in July, and investor bearishness remains quite high. This flow dynamic is explained by the still attractive yields in global fixed income markets.
Therefore, unless growth materially deteriorates, global central bank interest rates are reduced meaningfully, or Inflation rapidly re-accelerates, we could witness not only the persistence of tight credit spreads, but potentially see spreads reach new all-time tights.
The strategic opportunity
Despite that outlook, we would not be chasing this rally. For us it is not a question of ‘if’ credit spreads normalize toward their long-term averages, but a matter of ‘when’. The timing could be very near, or in several quarters.
Instead of guessing on binary outcomes, we see opportunities to introduce very cheap, convex hedges in our strategies, while maintaining high defensive yield in portfolios. This setup would allow us to extract healthy yield from the market, while leaving investors’ money positioned for protection from sharp spread widening when it comes.
The bottom line
The current environment offers both attractive yields and cheap insurance. Rather than timing the exact turn, investors can capture today’s tight spreads while hedging tomorrow’s inevitable widening – potentially creating one of the best risk- adjusted opportunities available.
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