The yield difference between corporate bonds and risk-free government bonds — a real-time measure of credit market risk appetite and economic stress.
Deeper Explanation
Credit spreads reflect the market's collective assessment of default risk and risk appetite. Narrow spreads (say, 1% over government bonds for investment-grade debt) indicate confidence and risk appetite — credit is flowing freely. Wide spreads (say, 5%+) signal stress, risk aversion, and potential credit crunch. Spreads widen dramatically before and during recessions as default fears rise and liquidity falls. Howard Marks considers credit spreads a key cycle indicator: spreads near historical lows suggest late-cycle conditions (excessive complacency), while spreads near historical highs suggest either crisis or maximum opportunity for credit investors willing to absorb risk. Spread trends are as important as levels.
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