Skinny Excess Returns for IG Corporates
July 17, 2025
Investment grade (IG) corporate credit spreads have come full circle since earlier this year. Remarkably, the spread widening that followed “Liberation Day” is a distant memory. In recent weeks, IG spreads have returned to a 76 option-adjusted spread (OAS), the tightest of the year, and only three basis points (bps) off of the tights since 2000, which we experienced in November 2024.1
With this in mind, how much more can credit perform? Today’s Chart of the Week shows IG corporate credit performance year-to-date. Total returns have rebounded nicely; however, the majority of this performance is due to the move in interest rates. Corporate credit excess returns over duration-matched Treasuries have provided only 46 bps of return, while rates have provided 285 bps.2
There is a case to be made for caution here. Tariffs remain a potential catalyst for volatility, and the Trump administration has demonstrated that it can change direction on tariff policy quickly (e.g., European Union, Mexico). The overall pushback of tariff increases to August 1 remains an overhang and leaves the Federal Reserve’s path fairly uncertain, although the market is still pricing in two interest rate cuts in 2025.3
As we enter the early part of earnings season, customer resiliency in the face of the tariff backdrop and inflation outlook will be a focus. Broadly, earnings expectations for the second quarter are relatively modest. Company rating trends for non-financials are starting to turn as downgrades exceeded upgrades in the second quarter of 2025 for the first time since the first quarter of 2021.4 Therefore, analysts will closely scrutinize management team commentary on their ability to pass through price increases.
Technicals for the IG market continue to be very constructive. New issuance for the first half of 2025 was the second busiest ever, behind 2020, with close to $1 trillion issued.5 However, on a net basis, supply has been in the middle of the pack for the last 10 years.6 In addition, Lipper reported another week of strong inflows into IG funds of $1.7 billion, representing the 10th straight week of inflows totaling over $27 billion.7 Pension performance is also supportive of spreads. In the first half of 2025, the pension funded ratio reached 105.1%, which is the second highest level since the Global Financial Crisis, just below October 2022, and an increase from 103.6% at the start of the year.8 The more fully funded a pension is, the more likely they are to enter derisking trades into long-end credit.
Key Takeaway
While technicals and the bid for yield have significantly contributed to attaining the current IG corporate credit spread levels, it is difficult to envision significant excess returns in the near term. I expect spreads to remain rangebound as more clarity emerges surrounding the durability of the consumer and the ability of corporations to pass on increased costs.
Sources:
1-3Bloomberg
4J.P. Morgan
5-7Barclays
8Milliman – Pension Funding Index July 2025; 7/8/25
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