BREAKINGVIEWS-Freakish credit markets could get weirder still

By Neil Unmack

LONDON, Sept 24 (Reuters Breakingviews) - In the long history of global debt markets, one core principle has been taken as read: governments borrow at cheaper rates than companies. Yet the gap between those two numbers, known as the credit spread, has narrowed to freakishly low levels of late.

From one angle, it might look like a corporate bond bubble. From another, there’s a compelling logic at play. So-called negative spreads, where companies pay lower interest rates than their sovereigns, have shown up in France. The phenomenon may become increasingly common.

Corporate debt has been one of the surprise winners of 2025. Yields have compressed, corresponding to higher prices, quickly shrugging off an April tariff wobble. American companies deemed “investment grade”, meaning that rating agencies score them triple-B or above, can on average borrow at just 0.74 percentage points over benchmark rates, according to the ICE BofA Corporate Index. The average over the past decade is 1.24 percentage points. In Europe, the spread is now 0.76 percentage points, which is one of the lowest levels since shortly before the 2008 collapse of Lehman Brothers. Returns for riskier high-yield debt, such as bonds issued by leveraged buyout targets, are also near record lows.

One example of how punchy valuations have become is the fact that bonds issued by high-quality companies sometimes yield less than those of fiscally challenged governments. Outside of emerging economies, it’s a phenomenon only occasionally witnessed during periods of stress, such as the 2012 euro zone crisis or the recent vote of no confidence against former French Prime Minister François Bayrou. A 2031 bond issued by luxury group LVMH LVMH.PA, for example, yields just 2.8%, which is 5 basis points lower than the equivalent borrowing cost for the government in Paris. BNP Paribas analysts said on September 15 that 7% of French investment grade companies were trading inside the sovereign.

The current market might seem extreme. Corporate spreads last reached today’s narrow levels in the run-up to the 2008 crisis. Indeed, the implied credit risk for companies is now so low that investors will be stung in anything but a benign economic scenario.

Take high-yield debt. The current spread over risk-free rates in the U.S. and Europe is around 2.7 percentage points, according to ICE BofA indexes. That implies very little return, after factoring in possible losses. Rating agency Moody’s reckons the global average long-term default rate for that category of debt is 4%, and that creditors generally lose 60% of their money when such highly leveraged companies hit the wall. Multiplying those two numbers together implies a 2.4 percentage point annual expected loss, which is close to the current credit spread. The implication is that even a small uptick from the norm, in terms of bankruptcies and debt restructurings, could entirely wipe out the risk premium on offer for high-yield bondholders.

Yet there are reasons why the frenzied demand for corporate debt may be rational. With rates still generally high, investors are keen to lock in returns, implying that they may be focusing more on the all-in yield than the spread. And despite the threat of tariffs eroding profitability, debt levels have stayed relatively steady. Faced with higher borrowing costs, and an uncertain political environment, many companies have steered clear of risky dealmaking and preserved their balance sheets. On average, even high-yield borrowers have median leverage in Europe equivalent to 3.2 times EBITDA, according to CreditSights data, which is only marginally above the level at the end of 2024. For less risky investment-grade companies, the equivalent ratio is a modest 2.4 times. As rates fall, defaults may become less common too, resulting in lower losses. Moody’s baseline high-yield default rate forecast of 2.6% over the next 12 months is far below the long-term average.

On the other hand, the Federal Reserve may end up cutting rates too quickly, perhaps pressured by U.S. President Donald Trump. That could prompt a new borrowing binge by incentivising companies to splurge on M&A or large share buybacks. Alternatively, vast investments in artificial intelligence data centres may turn out to be a waste of money, damaging stock markets and causing losses to lenders.

Still, the dangers are more explicit for governments. Advanced economies such as France, Britain and the United States have struggled to rein in spending, which soared during the pandemic. With politicians unwilling to face up to tough choices, sovereign leverage will keep growing. Debt issued by euro area countries, the United States and Britain is set to reach $73 trillion by 2030, from $58 trillion this year, per International Monetary Fund data. The five largest Western economies will boost debt to an average of 115% of GDP in that year, up from less than 110% currently, and compared with under 97% before the pandemic.

The upshot is that, over time, sovereign balance sheets are likely to keep getting worse, meaning that high yields will be required to tempt investors to keep absorbing all the public debt. “In today’s global environment, you can make the case that corporates are the defensive asset and sovereigns the risky one,” says Viktor Hjort, head of credit and equity derivatives strategy at BNP Paribas.

Absent a corporate credit meltdown, then, the French inversion phenomenon may become more commonplace. Take Microsoft MSFT.O. Credit rating agencies already deem it as more creditworthy than Uncle Sam, with the technology giant holding a pristine Aaa rating from Moody’s – one notch above the government. By 2030, its cash pile will reach $325 billion, according to analyst forecasts gathered by Visible Alpha. Microsoft bonds due in 2035 now yield just 2 basis points more than benchmark U.S. Treasuries maturing that year. Given the diverging fortunes, that positive spread is looking increasingly hard to justify.

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