The Other Yield Curve Investors Should Watch as Trouble Mounts

The Treasury yield curve is in focus. Here’s the other curve investors should keep an eye on

By Richard Barley

Gap between spread on short-dated and long-dated U.S. corporate bonds over Treasurys

Note: Based on one-to-three year and 10-year-plus corporate bond indexes

Source: ICE BofAML index via FactSet

Escalating trade tensions have helped push the U.S. Treasury yield curve to its flattest in more than a decade. This flattening is watched closely by investors as an indicator of economic trouble ahead. But another curve deserves attention too—and it is getting steeper.

That is the corporate-bond spread curve, which measures how much extra compensation investors are demanding to take credit risk at different time horizons. The U.S. curve has steepened, as spreads versus Treasurys have widened more on long-maturity bonds than they have on short-maturity bonds. 
Investors now get 1.7 percentage points more yield than Treasurys for corporate debt maturing in 10 years or more, versus 0.68 point for one-to-three-year debt, according to ICE BofAML indexes. Three months ago, the gap was roughly one-fifth tighter.

The message this sends is that while investors have become more uncertain about the longer-term outlook, they are relaxed about the near term. The longer a corporate bond’s maturity, the more credit risk it bears, since the underlying issuer’s business or balance sheet can face more challenges over time. In good times, that risk seems distant; when investors start to focus on it again, it is a sign of a changing environment.

Gap between two- and 10-year U.S. Treasury yields

Source: FactSet

Some think ultraloose global monetary policy has distorted the Treasury curve, potentially generating a false signal. So another indicator for investors to watch is valuable. For now, the credit curve only seems likely to get steeper, in particular because companies have issued a lot of risky long-dated debt. The size of the U.S. triple-B-rated 10-year-plus index has surged to $878 billion, from $235 billion 10 years ago.

Size of U.S. triple-B 10-year-plus corporate bond index

Source: ICE BofAML index via FactSet

The danger point is a combination of wider credit spreads and a flatter credit curve, which would signal deeper concerns about company balance sheets. The good news is this isn’t something corporate-bond investors are betting on—yet.

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