Investment grade and high yield corporate bond spreads over Treasuries. The bond market's real-time assessment of financial stress — updated daily from FRED.
What are credit spreads telling us about the economy?
Credit spreads measure the extra yield investors demand for holding corporate bonds over risk-free Treasuries. Wider spreads signal rising default risk and financial stress. Every US recession in the last 50 years has been preceded by significant spread widening — making them one of the most reliable leading indicators available to investors.
When a corporation issues a bond, it pays a higher interest rate than the US government because there is a chance the company could default on its debt. The difference between the corporate bond yield and the equivalent-maturity Treasury yield is the credit spread. This spread compensates investors for taking on credit risk — the possibility that the borrower won't pay back the principal or interest.
Credit spreads fluctuate based on investor perception of default risk, liquidity conditions, and broader economic outlook. During periods of confidence, investors accept lower spreads because they believe defaults are unlikely. During periods of fear, they demand much wider spreads, which drives up borrowing costs for corporations and can create a negative feedback loop in the economy.
The option-adjusted spread (OAS) refines this further by stripping out the value of any embedded options in the bond (such as call provisions), giving a cleaner measure of pure credit risk. The ICE BofA OAS indices — tracked on this page — are the global standard for measuring aggregate credit spread levels.
The bond market is often described as "smarter" than the stock market because bond investors are primarily institutional — pension funds, insurance companies, and central banks — with large analytical teams focused on fundamental credit analysis. These investors reprice credit risk before economic data confirms a downturn.
Historically, credit spreads begin widening 3 to 9 months before a recession officially begins. During the 2008 financial crisis, HY spreads surged from 300bp to over 2,000bp. During the 2020 COVID crash, HY spreads spiked from 350bp to over 1,000bp in weeks. Even smaller stress events like the 2015-2016 manufacturing slowdown and the 2018 Fed tightening scare produced significant but shorter-lived spread widening.
The key signal is the rate of change — not just the absolute level. A rapid widening from 400bp to 700bp over two months is more alarming than a steady grind from 400bp to 500bp over a year. The speed of the move reflects how quickly investor confidence is deteriorating.
Investment grade (IG): Bonds rated BBB- or higher (S&P) / Baa3 or higher (Moody's). Issuers include blue-chip corporations like Apple, Microsoft, and Johnson & Johnson. Historical default rate: below 1%. IG spreads typically range from 80bp (very tight, risk-on) to 300bp+ (stressed). The IG index tracked here (BAMLC0A0CM) covers the broadest measure of US investment grade corporate bonds.
High yield (HY): Bonds rated below BBB- / Baa3, also known as "junk bonds." Issuers include more leveraged companies, cyclical businesses, and fallen angels (former IG issuers downgraded). Historical default rate: 3-5% per year on average, but spikes to 10%+ during recessions. HY spreads typically range from 300bp (tight) to 800bp+ (distressed). The HY index (BAMLH0A0HYM2) covers the full US high yield market.
The ratio between HY and IG spreads also matters. When HY spreads widen much faster than IG, it signals that stress is concentrated in lower-quality borrowers — an early warning sign. When both widen together, it indicates systemic stress affecting all corporate borrowers.
Risk-off signal: When IG spreads exceed 200bp or HY spreads exceed 600bp, consider reducing exposure to cyclical equities and high-beta assets. These levels have historically preceded significant market drawdowns.
Buying opportunity: Extreme spread widening (HY above 800bp) has historically been a strong entry point for credit and equity. The risk premium becomes so large that even elevated default rates are more than compensated. March 2009 and March 2020 were both characterised by extreme spread widening followed by exceptional returns.
Cross-asset confirmation: Credit spreads are most useful when combined with other indicators. Watch for divergence: if equities are making new highs while credit spreads are widening, the equity rally may be on borrowed time. Credit markets are less susceptible to speculative excess than equity markets.
Peak confidence. Investors are complacent about credit risk. Historically this precedes a period of spread widening. Low compensation for risk-taking.
Market is pricing in moderate risk. Could represent fair value or the early stages of a wider move. Watch the direction and speed of change.
Distressed territory. The market is pricing in significant default risk. Historically a strong long-term buying opportunity, though near-term pain is likely.
Credit spread data sourced from FRED (Federal Reserve Economic Data). Series: BAMLC0A0CM (ICE BofA US Corporate Index Option-Adjusted Spread) for investment grade, BAMLH0A0HYM2 (ICE BofA US High Yield Index Option-Adjusted Spread) for high yield. Spreads are option-adjusted and measured in basis points over the Treasury curve. Data is published daily by the Federal Reserve Bank of St. Louis.
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