Risk Appetite Returns as Spreads Breach 300bps
The public high-yield bond market has entered a decided state of “Risk-On,” characterized by a significant compression in credit spreads. According to the latest data from the ICE BofA US High Yield Index, Option-Adjusted Spreads (OAS) have tightened effectively below the psychological 300 basis point threshold, trading at 2.88% as of mid-December. This level represents a market priced for perfection, where investors are aggressively actively chasing yield and discounting the potential for macroeconomic disruption.
This compression is visible across the credit spectrum. The ICE BofA Single-B US High Yield Index—which tracks riskier, lower-rated corporate debt—shows spreads effectively erasing the risk premium, tightening to 2.94% by December 23. Similarly, higher-quality BB-rated bonds saw spreads compress to just 1.81%. When investors are willing to lend to sub-investment grade companies for less than a 3% premium over Treasuries, it signals a consensus belief that corporate defaults will remain historically low and that a continuing economic “soft landing” is imminent.
The “Fear of Missing Out” Drives Valuation
The current tightening is less about a fundamental improvement in corporate balance sheets and more about the technical dynamics of capital flows. With interest rates stabilizing, capital that had been sitting on the sidelines is now flooding into fixed-income assets. Fund managers, under pressure to deploy cash and match benchmark returns, are being forced to bid up prices, driving yields down.
In this environment, public market terms often loosen significantly. To win allocations in hot deals, lenders in the public syndicated markets are increasingly accepting “covenant-lite” structures, waiving protections that would historically restrict a borrower’s ability to take on additional debt or pay dividends during periods of stress.
Implications for Borrowers and Lenders
For borrowers, this is an opportunistic window. The cost of capital in the public markets is currently inexpensive relative to the historical average. Companies able to access these markets are refinancing expensive debt and extending maturities at attractive rates.
However, for lenders and investors, the margin for error has evaporated. When spreads are this tight, the compensation for taking credit risk is minimal. Returns are generated purely through yield, with little to no capital appreciation potential left in the bond prices. If the credit cycle turns—or if inflation data surprises to the upside—the repricing in these assets could be swift and violent.
The Bond Capital View: Discipline Over Velocity
While the rampant liquidity in public markets is notable, Bond Capital maintains a position of credit discipline. We view the current spread levels as “priced for perfection,” leaving public market investors exposed if the macroeconomic narrative shifts.
Our strategy in this cycle is distinct:
- Structure over Yield: While public investors chase the lowest possible rate, often sacrificing covenants to get it, we focus on robust deal structuring that protects capital repayment in downside scenarios.
- Certainty of Execution: Public markets are fickle; a single bad inflation print can shut the window overnight. Private credit offers borrowers certainty of funds regardless of daily market volatility.
- Rational Underwriting: We do not lend expecting a “perfect” economic outcome. We lend against assets and cash flows that can withstand volatility, ensuring stability for our investors even when the public market “greed” cycle inevitably cools.
