The chart below shows the option-adjusted credit spreads for US BBB-rated corporate bonds with a 10-year maturity.
Credit spreads are always positive: for corporations to attract investors to buy their bonds they must offer a premium.
That premium is called ’’Credit Spread’’: it refers to the fact that corporate bond yields are higher than government bond yields or interest rate swaps.
Hence, investors willing to take the risk of a corporate default will be compensated with this premium – the credit spread.
So, what’s strange about the chart below?
US credit spreads are now sitting at 94 bps only.
That’s the tightest level in 25 years!
And it’s not only a US phenomenon.
Despite the non-negligible worries about French political jitters and ignoring what a bad French outcome could mean for Europe, the spread between and sits at levels seen during QE.
So, what does this mean?
Sitting on a long credit spread position means you get paid a nice spread until something happens and volatility comes to bite.
Investors convinced nothing bad can happen will end up going long credit spreads at very tight levels.
Effectively, today investors are selling volatility and receiving a low upfront premium for their risk.
Animal spirits are running loose.
Be careful out there.
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