The Bond Market Is Saying Something Different
As uncertainty around global trade policy has increased, so has volatility in U.S. stocks. Companies aren’t sure how to react to the dynamic tariff environment. This is captured in the National Federation of Independent Business’s Uncertainty Index, which recorded its second-highest reading in February (before much of the new tariff announcements). The concern is that business activity could stall as companies grapple with the ever-changing rules. And as of this writing, the S&P 500 has fallen into correction territory.
But the bond market is saying something different.
When U.S. companies issue bonds, they almost always offer an interest rate higher than the yield on U.S. Treasurys with a similar maturity. The difference between the yields of a corporate bond and a U.S. government bond is its “credit spread.” Investors demand this extra yield to compensate them for the risk that the corporate issuer could default on its debt. (It’s assumed that the U.S. government will not default on its debt obligations.) Credit spreads vary among companies: The higher the risk of a company defaulting, the higher the credit spread.
In aggregate, credit spreads fluctuate as the market continuously assesses default risk. When there are economic concerns, spreads widen. Conversely, when spreads are narrow, investors view economic conditions as favorable. Thus, credit spreads are a good gauge of investors’ perceptions of the health of the economy.
The exhibit shows credit spreads for high-quality U.S. bonds. During today’s equity-market volatility, credit spreads have increased. But importantly, they remain very contained and, at least for now, are not widening anywhere near the extent they did during previous recessions. (We made a similar observation for low-quality, “junk” bonds.)
Exhibit: Credit Spreads for High-Quality U.S. Bonds
Source: ICE Data Indices, Federal Reserve Bank of St. Louis, Clayton Wealth Partners.
Bullish
- The Fed has made good progress in reducing inflation since 2022.
- The Fed is now in an easing cycle.
- The most attractive yields for fixed income and cash in years.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Policy uncertainty is having a chilling effect on consumer and business sentiment.
- Slowing global economic growth.
- Housing affordability remains at a decades-low.
- Leading indicators of unemployment are generally trending down.
- Delinquency rates on consumer loans are rising.
- Russia-Ukraine war, Middle East conflict, and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.