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Earlier this week, we highlighted stock market internals showing significant strength despite weaker labour market data. This is at odds with previous spells of weakness like 2018 or 2024.
The credit market paints a similar picture. IG CDX at 47bps sits near all-time tights—first percentile since 2011. The HY market is equally complacent, with spreads just below 305bp, which is in the eighth percentile.
The credit market is now trading as if the US economy were firing on all cylinders. Not only are tight financial conditions hard to find, investors are pricing almost no uncertainty ahead. Even adjusting for index composition and improving quality mix, both markets price virtually no recession risk.
Tight spreads have enabled companies to ramp up issuance despite a slow start. June and July both saw over $35bn in new paper as the ‘Liberation Day’ panic eased. YTD issuance at $224bn is on track to surpass 2024, marking the third consecutive annual increase.
The most speculative parts of the credit market, CCC loans, are now yielding 10% (around 2019 levels) while spreads are tighter at just 620bp versus 750bp before the pandemic.
The bull case for credit is that profit margins for issuers of credit remain elevated versus history, with IG showing particular strength. In HY, while downgrades marginally outpace upgrades, the deterioration remains fairly benign (see here).
The bear case is that interest coverage ratios are deteriorating at 6.7x for IG and 3.6x for HY on a median basis, now sitting near historic lows. This is before the unemployment rate really has accelerated.
Overall, the credit market’s pricing offers asymmetrical opportunity if the economy is slowing. Slower growth and contracting profit margins will further deteriorate interest coverage, meaning spreads are likely 75-100bp too low. But for now, the market needs more evidence.
