Fluctuations in credit spreads serve as an indicator of investor sentiment and capital flows in the corporate bond market. “Credit Signal” provides an intuitive analysis of the market’s overall trends and context, focusing on weekly changes in credit spreads. <Editor’s Note>

[Edaily Marketin Reporter LEE GEON-EOM ] Despite domestic and international government bond yields surging across the board due to rising oil prices and concerns over U.S. interest rate hikes, fears of a contraction in investor sentiment in the corporate bond market have eased somewhat. Typically, during periods of sharp rises in government bond yields, corporate bond yields—which carry relatively higher risk—rise more quickly, causing spreads to widen. However, this week saw government bond yields rise even more sharply, resulting in a narrowing of spreads. Nevertheless, some observers point out that, given the upper limit of absolute yields remains open, it would be premature to interpret this as a full-fledged improvement in investor sentiment.

According to the Bond Information Center of the Korea Financial Investment Association on the 4th, the spread on “AA-” rated 3-year corporate bonds stood at 67.9 basis points (1 bp = 0.01 percentage point) as of the previous day. This represents a narrowing of 1.4 basis points compared to 69.3 basis points a week earlier, on the 27th of last month. The spread on 3-year “BBB-” rated bonds—which are non-investment-grade—also narrowed from 650.4 bp to 648.7 bp over the same period.

Looking at the details, the yield on 3-year government bonds rose by 13.3 basis points over the week, while the yield on ‘AA-’ rated 3-year corporate bonds rose by only 11.9 basis points. In effect, the spread narrowed as government bond yields rose more sharply than corporate bond yields.

The yield on the 3-year government bond reached 3.930% on the 2nd, marking this week’s high. The spread also narrowed to 67.0 basis points on the same day, hitting a weekly low. On the 3rd, the government bond yield edged down slightly to 3.888%, and the spread rebounded to 67.9 basis points.

The credit spread refers to the difference between the yield on government bonds—which are considered safe assets—and the yield on corporate bonds issued by individual companies. Since companies face a higher risk of default than the government, they must pay a higher interest rate to raise funds; this difference is the spread. A narrowing spread also implies that corporate bond yields have not risen as rapidly as government bond yields.

The epicenter of the rising interest rates is the Middle East. International oil prices surged after the U.S. and Iran resumed armed conflict on the 30th of last month. Brent crude futures, the international benchmark, surpassed $95 per barrel on the 1st.

Compounding this, Federal Reserve Chairman Kevin Warsh made more hawkish remarks than expected at the Jackson Hole Symposium last week, heightening concerns about monetary tightening. According to the CME FedWatch tool, the probability of a 25-basis-point rate hike by the Fed in September stood at 67.2% as of the 2nd. This figure is approximately 7 percentage points higher than it was a week ago.

Some observers believe that when inflation exceeds the real growth rate, this could actually have an adverse effect on credit spreads. They explain that since Treasury yields have not yet reached their peak, it is too early to conclude that spreads will narrow.

A bond portfolio manager at an asset management firm said, “When interest rates rise in the credit market, it is more important to see whether the credit yield spread holds,” adding, “It is still too early to conclude that the spread has narrowed.”

There are also arguments that spreads could narrow further. A bond portfolio manager at another asset management firm said, “Until recently, the prevailing sentiment was that interest rates had passed their peak,” adding, “If volatility in government bond yields decreases and economic growth forecasts are revised upward, spreads could begin to narrow.”

Meanwhile, the commercial paper (CP) market—which companies are turning to as an alternative to corporate bond issuance—is actually seeing an increase in funding costs. The yield on 91-day CP stood at 3.22% on the 4th. This marks a 6-basis-point increase over the past two weeks compared to 3.16% in mid-August. It is also higher than the 3.21% recorded on the 27th of last month, the day the benchmark interest rate was raised.