High Yield Spreads and How We Use Them

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High Yield Spreads and How we Use Them

March 25th, 2025

Christopher Mallon, CFP®

Today we are reviewing an important indicator we monitor and that is High Yield Credit Spreads.

High Yield Spreads1 are the difference in yield between high-yield (high risk “junk bonds” issued from companies with lower credit ratings) and the lowest risk bonds, US Treasury Bonds.

This is an important measure to watch, because it gives us a clear picture of what level of risk bond investors are willing to accept. A wider spread indicates investors perceive higher risk, demanding greater return for holding riskier bonds. Conversely, a narrower spread signals investors’ confidence in economic conditions and lower perceived risk2.

Reminder: The Yield on a single bond is the Maximum return a bond investor can receive if held until the bond expires. Unlike equity investors, bond investors have capped returns (limited to the yield) and significant potential downside if the issuer defaults. Therefore, bond investors tend to be quite sensitive to economic risks.3

This is important for us, because we can use this measure as a temperature check for very risk-averse investors. If very risk-averse investors are confident (indicated by low spreads) then we can be confident.

Long Term Chart: Jan 1997-Now (Recessions Shaded)

Source: Ycharts

Chart Takeaways

  • In two of the last three recessions, we saw spreads increase to above their long-term average of 5.27%. The one exception being the short recession in 2020 due to Covid.
  • Not all spikes indicate a recession as you can see in 2011-2012 as well as 2015-2016.

Recent History: January 2021-Present

Source: Ycharts

Chart Takeaways

  • Despite the recent increase, spreads are still below the average for the last four years of 3.72%.
  • Bond investors are not currently signaling above average concern of widespread defaults.

Final Thoughts

Monitoring high yield spreads gives us insights into bond investor confidence. Since bond investors can be particularly sensitive to risk, understanding their outlook helps our team make informed investment decisions aligned with the current economic environment.

Questions or comments? Reach me at chris@pcmadvisors.com

Footnotes

  1. https://fred.stlouisfed.org/series/BAMLH0A0HYM2
  2. https://www.investopedia.com/terms/h/high-yield-bond-spread.asp#:~:text=Higher%20spreads%20indicate%20a%20higher,broader%20weakening%20of%20macroeconomic%20conditions.
  3. https://www.investopedia.com/articles/investing/120315/corporate-highyield-bonds-vs-equities.asp#:~:text=A%20corporate%20bond%20has%20a,income%20generated%20by%20bondholder%20investments.

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