Bond Market Bonanza Leaves Investors With Razor-Thin Safety Net

(Bloomberg) — Bond investors are accepting the smallest compensation in years in return for taking default risk, as a potent combination of economic optimism and too much cash chasing too few securities skews costs.

Credit spreads — which measure the extra yield on riskier securities over those seen as safe, such as US Treasuries — are grinding lower across the world. That’s as muted financial volatility encourages investors to seek assets offering greater carry, ranging from company debt to emerging-market currencies.

The extra interest paid by investment-grade companies in US dollars is around the lowest level since before the dot-com bubble burst. The riskiest type of bank bonds have rarely been so expensive. A handful of borrowers are even trading at lower yields than Treasuries, flipping their spreads upside down for the first time.

As well as some evidence of improved fundamentals, bankers and fund managers point to a wave of investor cash seeking fixed-income assets. Outright yields are high by the standards of the last decade, enticing investors like pensions and insurance companies to lock in relatively high rates.

“There’s so much capital chasing financial assets,” said Robert Cohen, head of global developed credit at DoubleLine Capital. “Everyone’s looking for a bargain and the bargains get swept up pretty quickly.”

Global investment grade corporate risk premiums were 81 basis points on Wednesday, near their tightest since 2007, compared with an average of 116 basis points over the past five years.

Some of the repricing reflects a change in fundamentals: various metrics indicate companies can comfortably pay interest and meet debt maturities. At the same time, most major central banks are lowering interest rates — easing borrowers’ debt burdens.

There are also technical factors driving the spread compression. The rise in outright yields in recent years has sparked a boom in fixed-income strategies seeking to exploit the higher rates on offer, shifting the demand-supply balance.

The growth of credit index managers which passively hoover up the market, as well as yield-focused fixed-maturity funds, is likely helping to flatten out the differences in bonds’ yields. Insurance companies have also been packaging company debt into annuities to sell to retirees, further adding to demand.

For those wary of expensive valuations, it’s a test of patience. They could choose to stay out of a risk rally where too much cash is chasing too few assets. Yet for as long as volatility remains subdued, they’re stuck with lower-yielding assets that act as a drag on their overall returns.

FOMO Wins

For now, the fear of missing out, or FOMO, is winning. It’s a sentiment echoed across asset classes, with global stock indexes, gold, Bitcoin and others surging to record highs.

“Although much of the credit universe seems rich to us, there are plenty of buyers looking to enhance their yield in any way possible,” said Alexandra Ralph, senior fund manager at Nedgroup Investments in London. “There are worse places than public, liquid credit markets for yield hunters.”

When interest rates go up and stocks rally, the natural response of a retirement fund strategy with a fixed credit target allocation will be to rebalance by selling equities and buying bonds, according to Citigroup Inc. strategist Daniel Sorid.

“The combination of stronger equities and higher and higher yields has been to drive significant systematic flows from target date strategies in the US into fixed income more broadly,” he said in an interview.

In one of the most striking displays of yield-chasing abandon, Allianz SE raised $1.25 billion of perpetual notes that set a new low mark for spreads from financial firms this year and was still swamped with orders of as much as $12.5 billion.

Boom vs Doom

Emerging market issuers, meanwhile, have seen risk premiums on their US dollar bonds fall below 260 basis points earlier this month for the first since 2013, according to JPMorgan Chase & Co.

Spreads on Asian investment-grade dollar bonds tightened to their lowest on record at the start of the week at 60 basis points, less than half their 10-year average, a Bloomberg index shows.

The extra yield in junk bonds over their investment-grade counterparts is also near its lowest since the crisis, according to Bloomberg indexes.

The indiscriminate buying worries Guillermo Osses, head of discretionary EM debt strategies at Man Group, the largest publicly-traded hedge fund in the world.

“When markets stop distinguishing between creditworthy borrowers and potential problem cases, they typically signal that liquidity conditions, rather than economic reality, are driving valuations,” Osses said.

That leaves investors with a razor-thin buffer against a slowdown hinted at in recent US jobs data and weakening US services.

The American economy will likely start “cracking” by next year and yield premiums on investment-grade corporate bonds may widen to 130-140 basis points over a 12-month period, said Luke Hickmore, an investment director of fixed income at Aberdeen Investments and market veteran. That’s up from 76 basis points on Tuesday, a Bloomberg index shows.

“This is all lovely at the moment and we could go lower, but it feels quite fragile,” Hickmore said.

–With assistance from Sam Potter, Finbarr Flynn and Kerim Karakaya.

©2025 Bloomberg L.P.