By Shankar Ramakrishnan and Matt Tracy
(Reuters) -Investors have begun to de-risk their equity portfolios and buy more investment-grade corporate bonds as U.S. stock indices near new record highs, in turn pushing corporate borrowing costs to their tightest levels since 1998 for the second time in eight months.
Credit spreads have recovered since they were forced sharply wider on April 2, or ‘Liberation Day’, when President Donald Trump announced trade tariffs and the market became uneasy about corporate fundamentals in a potential environment made susceptible to inflationary pressures and slower economic growth.
The average investment-grade bond spread last stood at 80 basis points (bps), which is just 3 bps away from its lowest point of 77 hit in 1998 and had previously touched last November, according to ICE BAML data. It had touched 121 bps, or its highest since November 2023, in the days after Liberation Day.
The recovery has come on the back of optimism, confirmed by recent corporate earnings, that the highest-rated companies had used the past year to reform balance sheets by paying down debt, avoiding costly acquisitions, and were prepared for an economy impacted by the inflationary impulse of tariffs or a trade war.
“The sharp tightening of credit spreads seen since Liberation Day is based on perception that trade and tariff risks have peaked. . .it also can be attributed to investors’ confidence in US corporate fundamentals,” said Edward Marrinan, credit strategist at SMBC Nikko Securities.
The Federal Reserve’s reluctance to cut interest rates substantially, with inflation still stubbornly above preset targets, has also kept corporate bond yields high enough to attract strong demand from yield-focused investors like insurance companies and pension funds.
But worries that corporate valuations are nearing a peak have also prompted some investors to shift money from equities to investment-grade corporate bonds, adding an extra level of pressure on credit spreads, said bankers.
This heightened investor demand coupled with an overall market shift out of equities into debt could push spreads tighter in the coming months, said Michael Levitin, managing director and co-head of liquid credit at asset management firm MidOcean Partners.
“For the first time that I can think of in my career, we’re seeing a shift out of equities into debt,” he added, noting it was driven by those beginning to realize they may not get the same return out of equities as they did before.
“We have had more conversations, interest in credit strategies and investment-grade fixed income given the run-up in equities,” said Nick Elfner, co-head of research at Breckinridge Capital Advisors.
About $10 billion has moved out of domestic equity funds and ETFs since the beginning of 2025, at the same time as over $180 billion has flowed into taxable bond funds and ETFs, according to data from the Investment Company Institute. This reflects the added demand for fixed income, Elfner noted.
Companies in the meantime are taking full advantage of this rush of demand for their bonds and raising new debt, while paying little to no new-issue premium as order books are heavily oversubscribed.
The average new issue concession on nearly $51 billion of corporate bonds issued in July was a measly 2 bps with order books covered by over four times, according to Informa Global Markets data.
To be sure, analysts and strategists expect this dream run in spreads to reverse, albeit gradually, in the second half, especially if the current optimism about the tariff impact on credit fundamentals is found to be misplaced.
“Our base case for (investment grade) credit spreads is widening, not tightening, as we have a forecast of 110 bps through year-end, but that number is still well within the long-term median level for spreads (of) 130 bps,” said Winnie Cisar, global head of strategy at CreditSights.
Companies have had a lot of power to push through pricing to consumers and maintain strong margins despite these macroeconomic headwinds – yet a period of rising interest rates means interest coverage has come down from record highs in 2021 and created a mixed picture for credit fundamentals, Cisar added.
“If interest expense is somewhat elevated and concerns grow around the trajectory for growth and profit margins, that could act as a catalyst for a widening in spreads.”
(Reporting by Shankar Ramakrishnan and Matt Tracy; Editing by Alexandra Hudson)
