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Opinion Credit
With plenty of capital seeking a home and high grade credits well positioned, IG spreads will stay tight
by Duncan Sankey
Duncan Sankey
Portfolio director and head of credit research
Cheyne Capital
Post-COVID, companies are adroit at managing supply-chain disruptions
The Great Bear Market of Summer 2025 convulsed investors on 1 August. The first tremors began around 9:30am (EST) and the last aftershocks dissipated before lunch. Investment-grade (IG) spreads gapped 5% wider only to snap back to levels prevailing before the sell-off, where they have since more or less remained. And those levels are tight: at the time of writing, five-year CDS spreads for a broad universe of high grade (IG and BB) are trading in the 13th percentile on a 20-year retrospective; in absolute terms, we are only a few basis points off pre-pandemic tights. Meanwhile, CDS are relatively cheap to bonds: the option-adjusted spread over Treasuries on the Bloomberg Global Aggregate Corporate Index is back to pre-GFC levels.
I stand by my previous comments that this is a liquidity-driven phenomenon and that, while examples of tulip fever abound, dips are likely to be bought until the liquidity tide eventually ebbs. However, fundamentals might also be more supportive of current high grade credit than first appears.
Overall earnings beat expectations
First, the sky didn’t fall in after “Liberation Day”. On the contrary, Q2 earnings were better than expected, despite fears that a tariff pre-buy would be followed by a contraction. Of the 90% or so of S&P 500 companies that have so far reported, 76% and 77% beat earnings and revenues estimates, respectively, with 62% beating on the top and bottom lines (according to JP Morgan). And the earnings beat is substantial — 8.2% compared to an average over the previous four quarters of 4.8%.
In part, this reflects an understandable tanking of expectations in response to “Liberation Day”, followed by a less calamitous tariff reality. (So far, at least — the devil will be in the detail/execution.) Corporate managements, too, canned full-year guidances, casting the market adrift.
However, expectations and reactions are not the full story. First, high grade companies post-COVID have become adroit at managing supply-chain disruptions such as those precipitated by a mercurial trade policy. Second, companies both in the S&P 500 and Stoxx Europe 600 have experienced a material uplift in operating profits over the past decade, leaving them better positioned to manage tariff pressures without immediately resorting to swingeing and potentially demand-destructive price hikes. Auto giant GM initially estimated tariff costs at USD 4bn to USD 5bn but believed it could offset 30% through mitigation efforts. The execution of mitigation efforts will coincide with lower tariffs from headline deals, which could lead to further relief. Again, using GM as an example, a reduction in tariffs on Korean goods to 15% from 25% could reduce their tariff bill by several hundreds of millions of dollars.
Tax cuts are boosting free cashflow
Many companies will benefit from tax relief provided by the “One Big, Beautiful Bill”. The restoration of 100% bonus depreciation, immediate expensing of R&D for tax purposes, eased interest deductibility (using an EBITDA- rather than EBIT-based cap) and the extension or entrenchment of Tax Cuts and Jobs Act business provisions will all serve to cut cash taxes and boost free cashflow. These measures have earned plaudits from executives in sectors as diverse as aerospace, gaming and media, and should benefit a wide range of companies, including those in manufacturing, tech and telecom.
The upshot of the developments above is that, as long as recession risk remains in abeyance, we see some favourable revisions to earnings guidance through the back end of the year and some positive surprises in Q4 and full-year earnings. Will this prevent spread-widening in high grade credits if liquidity evaporates? Absolutely not. But it reinforces their defensiveness relative to the shakier end of HY (single B and below) and to private credit, where leverage is high, debt-service coverage is diaphanous and much depends on securing refinancing at lower rates.
Optically low default rates in these categories may already be masked by high levels of distressed exchanges and, in private credit, (uncompensated) PIK conversions, amortisation holidays and maturity extensions, which do not show up in the default statistics. As a result, even at current tight spreads, investors remain materially overcompensated for default risk in high grade credit — even if the same is not true for the other end of the credit spectrum.
