Credit Spreads at Historic Tights: What Now?

Money market yields have fallen to just over 3% following the Federal Reserve’s string of rate cuts. That marks a three-year low, and yet assets are still booming at $7.7 trillion. But with the Fed still in cutting mode, and rates set to fall further, these funds are starting to lose their luster.

Historically, when policy rates fell to 3% in the 1990s, money market growth stalled, according to Strategas Research. We appear to be witnessing a comparable dynamic today, as pressure to reach for more yield in credit and duration intensifies. However, a weaker dollar, persistent inflation and heavy government debt financing are tempering appetite for the long end of the curve. In other words, there’s a limit on how far out the curve investors are willing to extend.

Meanwhile, credit spreads (the yield premium for corporate bonds over Treasuries) just hit fresh multi-decade lows. Investment-grade spreads dipped below 0.83% to levels not seen since 1998, while high-yield spreads have tightened to 2007 levels. As a result, valuations are getting more stretched and upside is looking more limited these days.

The macro backdrop remains broadly supportive for credit: GDP growth is resilient, rate cuts are coming and inflation is cooling, though still sticky. While the labor market shows some fragility, sentiment may be buoyed by election-year optimism and softer political rhetoric. But one key risk is supply, given the massive debt issuance from AI hyperscalers, like Meta, Microsoft and Google parent Alphabet – as they look to double down on spending.

Still, many believe the credit market is well bid enough to absorb any additional supply. As Vanguard notes in a recent report, “We expect credit to outperform government bonds again in 2026. Yields are attractive across sectors, and underlying fundamentals remain broadly healthy. Spreads are tight but justified.”

In a report titled “Credit returns can withstand tight spreads,” Goldman Sachs is similarly constructive and believes spreads will remain range-bound despite tight starting valuations. “We think 2026 has the potential to be a repeat of 2025, with IG and HY markets still posting positive excess,” they noted.

There are several ways in which investors are placing their bets…

• Sticking with credit. Investment-grade corporate bonds are outperforming Treasuries as technical demand remains high. Even with massive new debt issuance from tech companies to fund AI buildouts, deals are being oversubscribed by five times. The iShares Broad USD High Yield Corporate Bond ETF (USHY A) took in $6 billion last year. Meanwhile, both the Invesco BulletShares 2027 Corporate Bond ETF (BSCR A) and the Schwab 5-10 Year Corporate Bond ETF (SCHI ) netted $2 billion each. The State Street SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB B+) also attracted strong inflows – to the tune of $1 billion.
• Going longer. Investor interest has shifted toward intermediate-term credit, which tends to be more reactive to rate cuts. The Vanguard Intermediate-Term Corporate Bond ETF (VCIT A) has topped the ETF flow charts to kick off 2026 – nabbing a spot among the top five flow leaders with roughly $3 billion in net inflows.
• Staying active. Investors are looking to the experts to extract additional yield beyond what traditional credit indices can offer. Both the PIMCO Multisector Bond Active ETF (PYLD ) and the JPMorgan Income ETF (JPIE ) are seeing heavy inflows as popular “all-weather” solutions for a volatile rate environment. PYLD has roughly 20% weighted in corporate bond exposure, while JPIE has roughly 12% parked in high yield corporate bonds. The former has doubled in size since launching in 2023, while the latter has swiftly reached $7 billion in assets in just four years.

As macro and credit conditions evolve, the pressure to move out of cash and reach for higher yield is building. Investors are looking for a smarter touch – and indexing can be plenty sophisticated, too. On Thursday at 8:40 am ET, I will be sitting down with Samarth Sanghavi, Head of Fixed Income Products at VettaFi, at our Winter Symposium to discuss current challenges, dive deeper into the team’s new fixed income indexing capabilities and learn how we’ve taken cues from active to build “smarter” indices.

“Here at VettaFi, we are excited to introduce a new suite of innovative fixed income indices that serve us transparent, precise benchmarks while also designed to minimize turnover, provide increased sampling opportunities and mirror real-world portfolio construction,” Sanghavi told me earlier this week.

For more news, information, and analysis, visit VettaFi | ETFDB.