The outlook for U.S. corporate bond spreads in 2025 appears uncertain, with investors and strategists anticipating increased market volatility. This projection stems from the potential impact of new government policies, which could fuel inflation and potentially slow the pace of interest rate cuts by the Federal Reserve.
Following the Federal Reserve’s December meeting, where interest rates were lowered by 25 basis points, corporate credit spreads – the premium over Treasuries paid by companies for debt – experienced a widening. Federal Reserve Chair Jerome Powell’s cautious remarks regarding future rate reductions, emphasizing the need for demonstrable progress in curbing inflation, contributed to this trend. The subsequent rise in Treasury yields, prompted by the Fed’s more hawkish stance, further exacerbated the pressure on spreads.
Strategists anticipate this pressure to persist, predicting a moderation in demand for corporate bonds, which had previously driven spreads to historically tight levels. BMO credit strategist Daniel Krieter notes the expectation of sustained elevated interest rates as a key factor contributing to this anticipated moderation in demand. He forecasts that this, coupled with challenges in corporate fundamentals and potential volatility arising from new policy implementations, will likely lead to wider credit spreads in the coming year. Krieter projects investment-grade bond spreads to reach a low of 70 basis points in the first quarter of 2025, before peaking at 105 basis points by year-end. Current spreads stand at 82 basis points.
The inflationary potential of anticipated policy changes is a significant concern. Nick Losey, portfolio manager at Barrow Hanley, highlights the inflationary bias of many current and proposed policies. This uncertainty surrounding the market impact of these policies is prompting companies to accelerate their debt-issuance plans, aiming to capitalize on favorable market conditions before potential disruptions.
Strategists predict a surge in investment-grade bond issuance next month, potentially reaching record levels between $195 billion and $200 billion, surpassing the previous high of $195.6 billion set in January 2024. Junk bond issuance in January is also expected to be substantial, estimated between $16 billion and $30 billion, compared to $28 billion in January 2024 and $20 billion in January 2023.
According to Blair Shwedo, head of public sales and trading at U.S. Bank, January is poised to be a busy month for bond issuance, contingent on a receptive secondary market. Despite recent market fluctuations, the current environment remains largely conducive to new issuance.
While volatility is anticipated, the potential for attractive returns on corporate bonds in 2025 persists. Andrzej Skiba, head of BlueBay U.S. fixed income at RBC Global Asset Management, emphasizes the higher starting yield levels compared to the challenging market conditions of 2022. He suggests that even with potential increases in Treasury yields and widening credit spreads, a flat or potentially positive total return on a 12-month basis remains plausible.
In conclusion, the trajectory of U.S. corporate bond spreads in 2025 hinges on a complex interplay of factors, including the implementation of new government policies, inflation trends, and the Federal Reserve’s monetary policy response. While market volatility is expected, the potential for attractive returns remains, particularly given the current yield environment. Investors should closely monitor these developments and adjust their strategies accordingly to navigate the potential challenges and opportunities that lie ahead.
