INSIGHTS

On November 03, 2025

AAM Viewpoints — Corporate Credit Spreads Are Tight. How Long Can They Stay That Way?

As has been widely reported, corporate credit spreads are tight. The question investors ask though is, “What does that mean?” and “How long can they stay that way?”

Credit spreads are the marginal additional yield required by investors who take on the additional risk of lending money to corporations by buying their bonds over and above what they would require lending money at the risk-free rate of government securities. The amount of the risk premium (credit spread) over risk-free securities varies constantly which is caused by several factors including an individual corporation’s credit quality, overall economic conditions (examples being GDP growth, unemployment, corporate earnings), liquidity in the market, the underlying interest rate environment and general investor sentiment for risk assets.

Looking at the last 25 years, the average credit spread on the ICE Bank of America US Investment Grade Corporate Index has been 147bps (basis points). This extra 1.47% over risk-free Treasuries is just an average and does contain several spread-widening events along the way including three recessions and a pandemic. Currently, the overall economic backdrop has driven “risk-on” investor sentiment spurred by good corporate earnings, positive GDP, solid equity performance, an easing Fed, lots of liquidity in the system and demand for income-producing products with employment softening (but still “ok”) — not to mention the likely economic stimulus coming from the recently passed “One Big Beautiful Bill.” This has led to investors feeling somewhat complacent. Therefore, today’s credit spread of about 80bps would be in line with expectations given those factors. As long as investors have a very positive view around risk assets, spreads will likely remain within a tight range and can stay that way for extended periods of time as seen in the chart below. In times like these, investors tend to look for yield in lower-rated credits, longer-duration assets (when yield curves aren’t inverted) or relatively illiquid investments while they wait for cheaper entry points they believe are “coming soon.” However, times like these tend to last longer and perform better than many investors expect.

Past performance is not indicative of future results.

A shortfall in corporate earnings would lead to credit spreads widening, but thus far in this cycle we continue to see companies report good earnings in the aggregate. In fact, even with analysts and companies themselves raising guidance and future expectations, companies have generally continued to report earnings “beats” despite an economic backdrop with several uncertainties regarding tariffs, geopolitical and trade concerns as well as a softening employment situation. This has provided some justification for the tight credit spread environment with company profit margins and earnings performance showing just how incredibly resilient companies have been of late. The fact that companies can issue debt in a very friendly, highly liquid primary market has also helped them extend maturities and lock in manageable rates, adding to the overall health of corporate balance sheets.

Source: FactSet | Past performance is not indicative of future results.

Another driver for widening credit spreads would be any deterioration of overall credit quality of the companies issuing the bonds, viewed most clearly by the default rate observed in the market for the lower-rated speculative or “high-yield” section of the credit spectrum. Recently, S&P published that the current default rate for below-investment grade credit is 4.8% with a downward trajectory (for their base case) in the near term. Investment grade bonds have very low default rates, so investors can look for increased ratings downgrades from investment grade to high yield that may portend any weakness in credit quality but in this cycle thus far haven’t been meaningful.

Over the past few months, risk-free interest rates have rallied mostly due to the Federal Reserve embarking on a rate-cutting cycle and speculation on how much they may cut going forward. The overall interest rate environment is important to yields available on credit and other risk assets, as credit risk adds additional yield over this rate through the credit spread. Looking forward, it will be important to assess “why” the Fed may be cutting. If they cut short-term rates because they feel that overall economic conditions are weakening, Treasury rates will likely continue to rally and spreads would typically widen, but probably not to the degree that Treasuries rally, muting much of any negative price movement and potentially providing positive total returns, especially in longer duration assets. If they are cutting short-term rates only to provide additional stimulus to risk assets and support to overall economic conditions (and then companies are able to capitalize on that to post continued earnings increases and strength), credit spreads will likely remain very resilient and could tighten from today’s levels of 80 basis point over risk-free rates, providing upside in return potential even from today’s tight levels on credit spreads. Of course, we don’t know the “real” answer to this currently, but it could become apparent and is worth monitoring.

While corporate credit spreads are currently tight from a historical perspective, there is room to tighten further, or at least stay in a tight range for some time. Income-producing assets, including corporate credit, provide important diversification and ballast to portfolios and could provide good relative value given current economic conditions and a positive outlook. For investors concerned about deteriorating economic or corporate conditions, they can still participate in the market but could look to minimize any spread-widening impact by focusing on higher-quality and a low-to-medium duration tilt toward income-oriented client portfolios. For now though, it seems we are settling in to the low side of a tight range for credit spreads and could remain there for longer than investors may think. Ultimately, the old adage of “you can’t fight the Fed” may provide enough reason alone to not sit out of the market or ignore the added yield over Treasuries in corporate credit.

CRN: 2025-1003-12902 R