Bond Spreads Sit Near 1998 Lows. What Can Push Them Higher.

Corporate bonds spreads haven’t been so narrow since Bill Clinton was president and Britney Spears was at the top of the charts. (Getty Images)

America’s safest companies are paying investors historically low rates for the risk of defaulting on their debt—it’s a boon for companies and unlikely to change soon.

Credit spreads—or the extra yield on riskier debt over virtually risk-free government securities—is at 0.78 percentage points, close to the low of of 0.75 percentage points seen back in July 1998. The result is reduced borrowing costs for blue-chip companies, all while their stocks run hot; the S&P 500 gained $5.13 trillion in value this year.

Investors currently find the total return on corporate bonds attractive, despite the small additional compensation for risk. This is especially true in an environment where worries about recession have eased, and the government’s high spending has put a black spot on the alternative, U.S. Treasuries.

“The biggest source of demand for $IG credit today remains all-in yield buyers,” Steve Caprio, Head of Credit Strategy at Deutsche Bank tells Barron’s. “These buyers prefer credit today over US Treasuries, given concerns over fiscal deficits.”

Over this quarter, since July to Wednesday, investors poured in $49 billion into exchange-traded funds with investment grade bonds, the most inflows over the same period since 2022. In the same period last year, $6 trillion moved out of these funds.

Spreads have been tight for months and a summer lull in new supply likely further pressed them down. In July and August, issuance of new investment-grade debt slipped under $100 billion, according to J.P. Morgan. In short, there was too much money chasing too few assets.

“Supportive supply/demand technicals over July and August have pushed spreads into uncharted territory, an uncomfortable position that underscores the need for” protection against a downturn, wrote Goldman Sachs’ Chief Credit Strategist Lotfi Karoui.

What Can Freak Out Markets—and Widen Spreads?

Much lower than expected U.S. economic growth could cause longer-term Treasury yields to drop even as spreads, or demand for risk premium, widen on corporate bonds.

“U.S. credit spreads are on borrowed time,” says analyst Tan Kai Xian of Gavekal Research. Corporate balance sheets are healthy and companies are easily able to pay interest, but “tariff hikes and continued uncertainty could tip the economy into recession,” he wrote in his note on Thursday.

Other reasons for higher spreads, according to Xian, could be increased supply of corporate bonds or lower long-term Treasury yields if the U.S. government decides to finance more of its deficit with short-term debt.

September is typically a month of higher new corporate bond supply, where the market has seen an average of $133 billion come in over the past four years, according to Eric Beinstein, Head of U.S. High Grade Credit Research and Strategy, at J.P. Morgan. Out of this, $65 billion has been issued during Labor Day week.

Bar is High for Worry

Any shift of supply dynamics in the corporate credit or Treasury market won’t imply any stress in the market and will likely push spreads higher only temporarily.

What the market needs to get spreads at or near its 10-year average of 1.24 percentage points isn’t a technical change, but true panic about the economy.

Now, “the bar for a meaningful selloff has risen,” Caprio said. “At this stage, a weak job hiring report wouldn’t be enough. It would take a negative non-farm payrolls print or a more forceful rise in jobless claims and continuing claims to get the market’s attention”

Investors are in a tricky spot. Historically low spreads mean there’s a significant room for spreads to go wider from here if the economic outlook worsens, but things aren’t terrible by any means nor are they as wonderful as the 1998-like spreads suggest.

“We don’t expect a recession, and credit default rates are generally only occurring in select pocket…but there is enough growth weakness ahead to worry us, especially given tight overall valuations to start,” Caprio added.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com.