In 1935, amidst massive economic uncertainty following the Great Depression, a new AA-rated corporate bond yielded just 70 basis points over Treasurys. This historical precedent, nearly identical to today's spreads, shows that low credit spreads are not necessarily a sign of complacency and can persist even if economic conditions worsen, challenging typical risk-pricing assumptions.

Contrary to fears of a spike, a major rise in 10-year Treasury yields is unlikely. The current wide gap between long-term yields and the Fed's lower policy rate—a multi-year anomaly—makes these bonds increasingly attractive to buyers. This dynamic creates a natural ceiling on how high long-term rates can go.

The credit market appears healthy based on tight average spreads, but this is misleading. A strong top 90% of the market pulls the average down, while the bottom 10% faces severe distress, with loans "dropping like a stone." The weight of prolonged high borrowing costs is creating a clear divide between healthy and struggling companies.

While default risk exists, the more pressing problem for credit investors is a severe supply-demand imbalance. A shortage of new M&A and corporate issuance, combined with massive sideline capital (e.g., $8T in money markets), keeps spreads historically tight and makes finding attractive opportunities the main challenge.

Fed rate cuts primarily lower short-term yields. If long-term yields remain high or rise, this steepens the curve. Because mortgage rates track these longer yields, they can actually increase, creating a headwind for housing affordability despite an easing monetary policy.

The expected wave of M&A and LBOs has not materialized, leaving the deal pipeline thin. This lack of new debt supply provides a strong supportive backdrop for credit spreads, allowing the market to absorb geopolitical volatility more easily than fundamentals would otherwise suggest.

Despite forecasting a massive surge in bond issuance to fund AI and M&A, Morgan Stanley expects credit spreads to widen only modestly. This is because high-quality, highly-rated companies will lead the issuance, and continued demand from yield-focused buyers should help anchor spreads.

The deleveraging that followed the 2008 financial crisis—simpler bank balance sheets, more corporate cash, and tighter lending—created a multi-year environment where corporate bond supply was constrained. This scarcity insulated markets from supply-driven volatility, a condition that is only now ending.

A steep yield curve makes fixed annuities more attractive for consumers. Life insurers sell more of these products and invest the proceeds into spread assets like corporate bonds, creating a powerful, non-obvious demand driver for the credit markets.