Credit spreads

Here’s our first time discussing fixed income! Despite being often overlooked, it's crucial to understand its response to stock market performance.

• Reward for Taking Risk

  • Credit spreads is the difference in yields between a corporate bond and a risk-free Treasury bond of the same maturity.

  • Spread difference compensates investors for the higher risk of bonds not backed by the government.

• Indicator of Economic Health

  • Uncertain economy: investors demand higher returns for riskier corporate bonds —> Wide credit spreads

  • Stable economy: investors are more willing to take risks on corporate bonds —> Narrow credit spreads

• Prediction of the Stock market

  • Sales of corporate bonds are used to "test" the credit markets, as investor have the same market sentiment.

  • Investors buying corporate bonds = confident in the market.

Credit spreads spiked recently (08/2024) due to high economic volatility, indicated by the VIX peaking. The spike was driven by a sharp drop in U.S. stocks, increasing pressure for interest rate cuts, and a decline in Japanese stocks following a sudden interest rate hike by the BoJ.