Equity Credit Risk

Quick Take

📈 Spikes in BBB Credit Spreads reflect investors De-risking from corporate bond positions into risk free treasury bonds. De-risking behavior points to pessimism in the economic conditions that would support riskier assets. ⬆️ Higher Spreads lead to 👉🏽 a higher risk that corporates will default on debt payments to investors

Rising Spreads

When BBB credit spreads are rising or widening, the market is signaling an increased perception of risk associated with BBB-rated corporate bonds compared to risk-free government bonds. This can be due to a variety of factors, such as economic uncertainty, market volatility, or concerns about the creditworthiness of lower-rated companies. Investors demand higher yields (by selling corp bonds) to compensate for the additional risk, leading to an increase in credit spreads.

Example 1 If a significant number of companies in a particular industry face headwinds such as declining revenues or increased competition, the market may become concerned about their ability to meet their debt obligations. As a result, the credit spreads for BBB-rated bonds issued by companies in that industry may widen as investors demand higher yields to compensate for the increased risk.Example 2During an economic downturn, market participants may become more risk-averse and shift their investments away from riskier assets like lower-rated corporate bonds to safer assets such as government bonds. This flight to safety can lead to a widening of BBB credit spreads as investors demand higher yields to invest in BBB-rated bonds.

Fallling Spreads

On the other hand, when BBB credit spreads are falling or narrowing, the market is signaling a decreased perception of risk associated with BBB-rated corporate bonds compared to risk-free government bonds. This can be due to factors such as economic stability, improving credit conditions, or increased investor confidence in lower-rated companies. Investors are willing to accept lower yields as they perceive less risk in these bonds.Example 1If an industry that previously faced challenges starts to show signs of recovery, such as increased revenues or improving market conditions, the market may become more confident in the creditworthiness of companies in that industry. As a result, the credit spreads for BBB-rated bonds issued by companies in that industry may narrow as investors require less compensation for the perceived risk.
Example 2During economic expansion, market participants may become more risk-tolerant and increase their investments in riskier assets like lower-rated corporate bonds. This increased appetite for risk can lead to a narrowing of BBB credit spreads, as investors are willing to accept lower yields to invest in BBB-rated bonds.
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