On November 8, 2024, the Bloomberg U.S. Corporate Bond Index’s average option-adjusted spread (OAS) to Treasuries hit a 20-year low of 74 basis points (bps).1 Since then, the index average OAS has hovered around 80 bps. Despite volatility in both interest rates and equities, corporate credit markets have remained remarkably resilient.
Average corporate OAS is a widely used measure of credit spreads, representing the yield premium corporate bonds offer over Treasuries of similar maturities. A higher spread indicates that investors demand a greater discount relative to Treasuries to compensate for corporate credit risks. Corporate OAS reflects the relative value proposition between corporate bonds and Treasuries.
Several fundamental factors explain today’s historically tight credit spreads, including a healthy economy, strong corporate balance sheets and robust demand from income-focused investors. However, another critical factor is the growing supply imbalance between corporate bonds and Treasuries, which is reshaping their relative value dynamics.
As illustrated in today’s Chart of the Week, the total outstanding amount of bonds in the Bloomberg U.S. Corporate Bond Index has increased by $2.3 trillion since 2019, while the total outstanding amount in the Bloomberg U.S. Treasury Index has surged by $5.7 trillion.2 Consequently, Treasuries now comprise 44% of the Bloomberg U.S. Aggregate Index, up 5% from 2019, whereas corporate bonds have declined to 24%, down 1%.3 This indicates corporate bonds have become scarcer relative to Treasuries, tightening credit spreads.
The U.S. government has significantly expanded fiscal spending since the COVID-19 pandemic, leading to a cumulative fiscal deficit of over $10 trillion in the past five years.4 This deficit has been primarily financed through Treasury issuance. While the Bloomberg U.S. Treasury Index does not include all outstanding Treasuries, it remains a strong proxy for the investable Treasury market. In contrast, higher interest rates have discouraged corporations from aggressive public borrowing as they seek to avoid excessive interest costs.
This shift in relative value is also evident in derivatives markets. The spread between the 10-year Treasury yield and the 10-year secured overnight financing rate (SOFR) swap rate has widened from around 20 bps in 2020 to over 40 bps recently.5 If we consider the 10-year SOFR swap rate as the true risk-free rate, this suggests that the rising term premium — a key risk premium in Treasuries — is likely linked to the increasing supply of government debt.
Key Takeaway
Corporate credit spreads relative to Treasuries remain historically tight. While strong corporate fundamentals play a significant role, relative value dynamics between corporate bonds and Treasuries are also an important underlying factor. The rapid increase in Treasury supply has incrementally reduced their attractiveness compared to other fixed-income assets. Instead of corporate bond risk premium shrinking, it is possible that some of the risk premium has simply migrated into the Treasury market as investors demand greater compensation for holding government debt.
Sources:
1-5Bloomberg
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