Chart to watch: Are corporate credit spreads too tight?

Credit spread: The difference in yield between securities with similar maturity but different credit quality, often used to describe the difference in yield between corporate bonds and government bonds. Widening spreads generally indicate a deteriorating creditworthiness of corporate borrowers, while narrowing indicates improving.

Corporate bond:  A bond issued by a company. Bonds offer a return to investors in the form of periodic payments and the eventual return of the original money invested at issue on the maturity date.

Interest rates: The amount charged for borrowing money, shown as a percentage of the amount owed. Base interest rates (the Bank Rate) are generally set by central banks, such as the Federal Reserve in the US or Bank of England in the UK, and influence the interest rates that lenders charge to access their own lending or saving.

Yield: The level of income on a security over a set period, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.

Investment grade: A bond typically issued by governments or companies perceived to have a relatively low risk of defaulting on their payments, which is reflected in the higher rating given by credit ratings agencies.

Spread compression: Spread compression refers to the narrowing of the yield spread between different types of financial securities. The yield spread is the difference in the yield between two securities, typically between a risk-free or benchmark security (like US Treasury bonds) and another security that carries a higher risk (like corporate bonds or specific asset-backed securities).

Technicals: In the context of financial markets, “technicals” refers to the analysis of price movements and trading volumes of financial instruments, such as stocks, bonds, or commodities, to forecast future price behaviour.

Corporate fundamentals: These refer to the essential and quantifiable factors that indicate the overall financial health and operational efficiency of a corporation. These fundamentals are critical for creditors and investors as they assess the creditworthiness and investment potential of a company.

Dispersion: This refers to the variations or differences in returns among various securities within a specific asset class or across different asset classes. Intra sector dispersion refers to this phenomenon between sectors within one asset class.

Capital expenditure: Money invested to acquire or upgrade assets such as buildings, machinery, equipment, or vehicles in order to maintain or improve operations and foster future growth.

Net supply: In the context of fixed income, “net supply” refers to the total amount of new bond issues coming to the market, minus the volume of maturing debt that is being repaid and coupon payments, within a specific time period, typically within a year.

Deficit spending: Deficit spending occurs when a government’s expenditures exceed its revenues during a specific period, typically a fiscal year. This situation requires the government to borrow money to cover the shortfall, leading to an increase in public debt.

Monetary policy: The policies of a central bank aimed at influencing the level of inflation and growth in an economy. Monetary policy tools include setting interest rates and controlling the supply of money. Monetary stimulus refers to a central bank increasing the supply of money and lowering borrowing costs. Monetary tightening refers to central bank activity aimed at curbing inflation and slowing down growth in the economy by raising interest rates and reducing the supply of money.

Fiscal stimulus: Fiscal measures are those related to government policy regarding setting tax rates and spending levels. Fiscal austerity refers to raising taxes and/or cutting spending in an attempt to reduce government debt. Fiscal expansion (or ‘stimulus’) refers to an increase in government spending and/or a reduction in taxes.

Multiplier effect: The multiplier effect refers to the economic concept where an initial injection of spending leads to increased income and consumption, thereby generating more economic activity than the original amount spent.

Carry: Return earned from a security assuming its price remains unchanged. For a bond, carry is essentially the income generated by the bond less the cost of financing.