It should be no surprise that this past year in financial markets has been different, with public policy changes affecting the cost of capital in both the public and private sectors.
Recent moves in interest rates and currency valuations point to growing concern over the reliability of the United States as a trade partner and financier.
Should the U.S. no longer be perceived as a safe haven during times of stress, there is a strong risk that the cost of capital inside the U.S. will rise further.
This risk is the primary reason why we think a sense of complacency has set in among domestic corporate bond investors.
Last year, the yield spread between investment-grade corporate bonds and the benchmark 10-year Treasury widened to nearly 200 basis points before the April tariff announcement.
That spread has since moderated, dropping to as low as 160 basis points in July before widening out again in December and January.
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The recent ebb and flow of interest rates coincide with the market’s reaction to moments of geopolitical stress and concerns over economic growth and corporate earnings.
Wider spreads between investment-grade bonds and yields in the Treasury market imply the rising risk of private-sector default should economic stress persist.
Growth of the U.S corporate market
The widening of spreads this year comes after a decade of growth and reduced risk.
The corporate bond market has benefited from increased interest in the U.S. service sector and an economy that is now reaping the rewards of productivity investments.
Corporate investments in productivity were initiated specifically in response to the shortage of labor during the pandemic, with the payoffs coming years later.
Even so, the attractiveness of the U.S. corporate bond market is not something new. In the years since the financial crisis, the liquidity of the corporate market has grown along with confidence in the U.S. economy and the strength of the U.S. dollar.
The corporate bond market has grown at a 4.3% yearly pace, reaching an estimated $11.4 trillion as of October.
Issuance of investment-grade bonds has been growing at a 4% yearly pace, reaching an estimated $1.7 trillion over the same period of time, while trading volume is increasing at a rate of 9.1% per year.
Shrinking risk premiums
This attractiveness is evident in the shrinking yield spread between so-called investment-grade corporate bonds and U.S. Treasury bonds since 2012, interrupted only by economic and policy shocks.
Investment-grade yield spreads of 140 basis points in late 2024 were the lowest since 2008. Spreads in the riskier so-called high-yield corporate bond market over Treasuries have followed the same moderating pattern.
The takeaway
The higher yields available in the U.S. corporate bond market have become attractive for domestic and foreign investors, because of increased liquidity in the market, the growth of U.S. productivity and the strength and amplified returns of dollar-denominated securities.
But both the corporate bond market and the Treasury market have been buffeted by recent policy disruptions.
Wider spreads and a higher cost of capital seem inevitable should geopolitical concerns continue to ratchet up.
