Market Turbulence Ahead: Corporate Bond Spreads Set to Widen in 2025
As the Trump administration prepares to implement its reform agenda, investors and strategists are bracing for a bumpy ride in the U.S. corporate bond market. The new policies are expected to be inflationary, which could slow the pace of interest rate cuts and lead to increased market volatility.
Fed’s Hawkish Stance Sparks Spread Widening
Last week, the Federal Reserve’s December meeting sent corporate credit spreads widening, as the central bank cut interest rates by 25 basis points but expressed caution about further reductions without seeing progress in lowering stubbornly high inflation. The subsequent rise in Treasury yields added to the pressure on spreads.
Moderating Demand and Struggling Fundamentals
Strategists predict that demand for corporate bonds will moderate in 2025, driven by expectations of elevated interest rates. This, combined with struggling corporate fundamentals and market volatility, is likely to send credit spreads wider. “We expect demand to moderate somewhat in 2025 given the expectation for rates to remain elevated,” said BMO credit strategist Daniel Krieter.
Credit Spreads to Touch New Highs
Krieter forecasts investment-grade bond spreads to touch a low of 70 bps in the first quarter of 2025, before peaking at 105 bps by the end of next year. The uncertainty surrounding the new administration’s policies is expected to push companies to bring forward their debt-issuance plans to the first quarter.
Record Bond Issuance Expected
Some strategists predict investment-grade bond issuance next month to touch between $195 billion and $200 billion, setting a record. Junk bond issuance in January is expected to range between $16 billion and $30 billion, according to one strategist.
Robust Demand Despite Volatility
Despite potential volatility, demand for new bonds is expected to remain robust, driven by attractive returns on corporate bonds. “The good news is that unlike in awful 2022, the starting yield level for the asset class is high. Even if both Treasury yields rise further and credit spreads widen, you’re still likely to have at worst a flattish total return on a forward-looking 12-month basis,” said Andrzej Skiba, head of BlueBay U.S. fixed income at RBC Global Asset Management.
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