Global investors are turning cautious on corporate credit markets, warning that current pricing levels are far too optimistic given slowing economic data. Credit spreads — the extra interest corporations pay over government bonds — have fallen to their tightest levels in nearly three decades, reflecting expectations of strong growth that analysts say are unrealistic. Asset managers, including Fidelity International, have moved into defensive positions, avoiding cash bonds and shorting high-yield debt, anticipating a possible market correction.
The investment-grade bond spread stood at 78 basis points last week, just one point above its 1998 low, signaling a valuation disconnect from official forecasts. While global equities, including European stocks and major Wall Street indices, continue to post strong gains, analysts caution that corporate credit may be the most overvalued asset class. If economic growth in the United States slows further, they warn, corporate credit could face sharp declines — a scenario that often precedes equity market downturns.
Historical patterns show that credit markets tend to lead other asset classes in downturns, with passive corporate credit funds typically falling before equities. Recently, banks such as Citi have reported increased demand for derivatives that profit from falling credit values, indicating growing investor appetite for hedging against market risk. Analysts say this behavior suggests a growing belief that equity markets could see significant downside over the next three months.
High-yield debt appears particularly vulnerable, according to Amundi Investment Institute, with refinancing costs and default risks expected to rise as soon as October. Analysts cite potential tariff-related pressures and cash flow issues that could ripple into employment, investment, and broader economic growth. The premium junk-rated borrowers pay over investment-grade companies in the U.S. has fallen to around 2.8% — its lowest level since 2020 — reinforcing concerns about complacent risk pricing.
Market strategists from UBS and Russell Investments argue that current credit spreads are effectively pricing in global growth of nearly 5%, far above the International Monetary Fund’s forecast of 3%. With the IMF assigning a 40% probability of a U.S. recession and warning of knock-on risks to other major economies, analysts believe the “Goldilocks” scenario reflected in bond markets is overly optimistic. As investors reposition portfolios, the credit market’s vulnerability could serve as an early warning for stock market corrections ahead.
Source: Leadership