Assessing Risk From Increasing Bond Yield Spreads

With equity volatility creeping up in August, attention is shifting to credit markets given equity volatility is a key component of credit spread valuation models. While the VIX index has moved up to 17% from a low of 13% in July, credit spreads are little changed and have yet to respond to the rise in equity volatility. The valuation challenge for credit would become bigger if the rise in equity volatility persists, if government bond yields rise further or if the downgrade/default cycle evolves. In fact, compared to government bonds, credit looks already expensive as implied by the low level of corporate bond spreads compared to government bond yields. The rise in downgrades including downgrade reviews by ratings agencies suggests that a US credit cycle is already evolving. Rating downgrades including downgrade reviews typically precede defaults and are more timely indicators of credit perception changes. Indeed defaults appear to be following rising downgrades with this year’s volume of defaults on track to be the third highest on record in dollar terms. Rising downgrade risk appears to be already putting downward pressure on total vs. credit spread returns. The other valuation challenge for publicly traded credit markets stems from their comparison with private credit markets. Over the past year activity from public leveraged loan markets has shifted to private credit markets, suggesting price discovery for new credit is increasinglytaking place in private markets. And the yield divergence between private and public credit markets remained wide in July at around 300bp, posing a valuation challenge for public credit markets. Finally delinquencies are rising in consumer credit and commercial real estate. The Trepp US CMBS delinquency rate for office jumped by 338bp since December, suggesting that the deterioration in credit quality in office sector may already have entered a non-linear phase. Moreover, Trepp reported for July a greater rate of delinquency for larger (above $50m) loans, a rare occurrence as typically larger loans have lower delinquency rate. This occurrence happened only twice in the past during periods of economic weakness I.e. in July 2012 and June 2020 when the overall delinquency rate went above 10% in both cases. In all, rising downgrades, defaults and delinquencies suggest that a US credit cycle is emerging which is likely to worsen into 2024 given stalled credit creation and persistently high refinancing costs.

Cash bond yields tempt. The small print is duration. You earn carry, but you also wear a long fuse. When the back end twitches, months of income can vanish in a day. That’s not drama. That’s math. Here’s the uncomfortable truth: most investors don’t choose duration; spreads choose it for them. A tight spread on a long bond feels safe until rates move. Then you find out your “income” was leverage in disguise. If you can’t hold through a rate shock, you didn’t buy yield. You rented risk. Carry you can keep beats yield you can’t hold. I’d rather own short-dated IG with clean balance sheets than stretch for a few extra basis points in long HY with thin covenants. I want duration where I pick it, not hidden inside credit. If I add length, I pair it with liquid hedges and clear exits. Pride doesn’t pay coupons. Cash does. The curve still matters. Front end gives you carry and optionality. The belly can work when cuts arrive on schedule, not hope. The very long bond is a tool, not a home. Use it for a reason: liability matching, a hedge, or a defined trade. Not because the yield looks neat on a slide. Know your DV01. If you don’t know how much a 25–50 bp move costs you, you’re not managing risk. You’re guessing. A portfolio that bleeds on small rate moves won’t be around for the big win. Size like you plan to survive boredom and shock. Credit spreads look calm—until they don’t. They don’t give you a countdown. They gap. If growth cools or policy bites, refinancing risk shows up fast at the weak end. That’s when owning quality feels “boring” right up until it saves the month. Boring is a strategy. Tactics I like now: keep a T-bill sleeve for dry powder. Skew to short IG over long HY. Add a measured belly position where valuations are fair. Use simple hedges instead of cute structures you can’t exit. If volatility is cheap, rent some. If it’s rich, cut size and wait. And remember: income is not a trophy. It’s a stream that needs defense. Rebalance winners. Trim length into rallies. Add only when the tape gives you paid risk, not just risk. The goal is steady compounding, not yield cosplay. Are you choosing duration, or is it choosing you? What’s your portfolio DV01 on a 50 bp bear steepener? Which bonds still pay you for the credit risk? Where would you cut first if the long end jumps? What lets you hold through a bad week without panic? For more see our Nomura CIO Corner: https://lnkd.in/e4TCax_g Appreciate @Tathagata @Anuragh @Dhrumil for the sharp back-and-forth #fixedincome #bonds #rates #duration #yield #credit #carry #treasuries #riskmanagement #portfolio #CIO #Nomura

🧠 Two Credit Spread Indicators to Watch Even if you are not a direct investor in credit bonds, sometimes it pays to watch the credit spreads for signs of cracks in the market before equity markets fully react. We'd rather be early than late right? When assessing the general credit health of the market, two signals deserve close attention: the #CDX Investment Grade Spread and the ETF I-Spread (as seen in #LQD). 📌 1. CDX Investment Grade (White Line on Chart) A synthetic measure of credit risk, CDX represents the cost to buy protection on a basket of investment grade (IG) names via credit default swaps (CDS). A rising CDX = rising fear. Since it is a synthetic, liquid market, it is often the fastest-moving credit risk barometer, reacting instantly to macro shocks, liquidity crunches, or systemic risk. Think of it as the "credit VIX" — high-frequency and highly sensitive. 📌 2. ETF I-Spread (Orange Line) The I-Spread compares the yield of a bond ETF like LQD to a duration-matched Treasury. Higher I-Spreads = investors demanding more compensation for credit risk in cash bonds. This spread reflects supply/demand pressures, ETF flows, downgrade concerns, and broad credit appetite in the cash bond market. 📉 Why These Indicators Matter When both CDX and I-Spreads are rising, the market is flashing broad credit concern. But when they diverge, it tells you something deeper: ➡️ CDX > I-Spread: synthetic markets are more risk-averse than the cash market — possibly signaling hedging activity or fear before it's priced into bonds. Less noise more signal. ➡️ I-Spread > CDX: cash bonds may be under pressure due to ETF outflows or idiosyncratic stress — technical selling, not systemic risk, may be driving the move. This can still be useful as you tells you to look for OTHER reasons why the ETF I-Spread diverges. This month's chart shows that the seas are calm in credit. Notice that spreads are near the bottom of the range for the month, likely a reflection of the subsidence of turmoil related to permanent tariffs. CDX tightening modestly while LQD’s I-Spread compressed even faster, suggesting ETF demand is absorbing credit risk more aggressively than the CDS market. 🧭 Interpretation: Cash is healing faster than CDS — perhaps a sign of yield-hungry investors stepping back into IG. All this is a signal of constructive credit sentiment — for now. 💡 For Fixed Income Investors Whether you're managing duration, evaluating risk-on/risk-off signals, or assessing dislocation opportunities — tracking both synthetic and cash credit spreads offers a fuller picture of the market's true credit tone. Nothing screams #activemanagement more than investing in credit. 📊 *FICM Chart sourced from Bloomberg #CreditMarkets #FixedIncome #ETFs #BondMarket #MarketSignals #InvestmentGrade #MacroRisk #SanJacAlpha #SpreadTrading #PortfolioInsights

The Fed is cutting rates to support the labor market, but the market is raising yields to protect itself. While consensus blames stronger growth lifting the US neutral rate (r∗), the pattern suggests something darker: US term premiums are climbing even as policy eases, indicating emerging 𝐅𝐢𝐬𝐜𝐚𝐥 𝐃𝐨𝐦𝐢𝐧𝐚𝐧𝐜𝐞 rather than economic vigor. The 𝐔𝐒 𝐭𝐞𝐫𝐦 𝐩𝐫𝐞𝐦𝐢𝐮𝐦, the extra compensation investors demand for bearing long-duration risk, has risen to 0.79% even with expected rate cuts. This decoupling is highly critical because the sheer level of risk compensation already approaches the threshold historically associated with structural distress. While exceeding 1% during a Fed easing cycle confirms that fiscal issuance, not monetary policy, is the dominant driver of the yield curve, the current level reveals that the price of duration risk is already elevated. Critically, the volatility of the term premium tends only to increase during economic downturns and periods of uncertainty (countercyclical behavior).  Indeed, the “strong economy” narrative is fracturing beneath the surface. The latest NY Fed Survey of Consumer Expectations shows median one-year inflation expectations holding at 3.2 %, but 𝐞𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐠𝐨𝐯𝐞𝐫𝐧𝐦𝐞𝐧𝐭 𝐝𝐞𝐛𝐭 𝐠𝐫𝐨𝐰𝐭𝐡 jumped to 9.2 % and expected tax hikes spiked to 4.1 %, both the highest readings since mid-2024. This erosion of Washington’s credibility is being priced directly into the term premium. Crucially, under fiscal dominance, long‑duration Treasuries will shed their safe‑haven role as swelling sovereign issuance and their weakening ability to hedge equity drawdowns push the bond risk premium higher. Bonds will increasingly fall alongside equities, eroding the duration ballast that 𝐭𝐫𝐚𝐝𝐢𝐭𝐢𝐨𝐧𝐚𝐥 𝐩𝐨𝐫𝐭𝐟𝐨𝐥𝐢𝐨𝐬 still take for granted. Thus, today’s elevated term premium signals rising duration risk. It shows that US sovereign supply worries are overtaking short‑term monetary expectations as the main driver of long‑term yields. Investors should urgently adjust. #economics #finance #markets

Recent market movements and what they mean for bank ALM 🏦📉📈 Over the past few weeks, we’ve seen something unusual on the markets. U.S. bond yields—especially on long-term maturities (10y to 30y)—have risen significantly. This means bond prices fell hard. At the same time, major U.S. equity indices dropped sharply as well. So, what did investors do? They didn’t rotate from bonds to stocks … They exited USD assets altogether. This is supported by the EUR/USD exchange rate, which recently moved above 1.13—its strongest level against the dollar since early 2022. On the European and UK bond markets, we don’t see similar sell-offs, despite the fragile economic outlooks. For banks, especially from an ALM perspective, this is important. While a sound bank should not be exposed to equity or FX risk, interest rate risk and credit spread risk are a different story. This situation presents a real challenge for banks holding U.S. Treasuries. IRRBB compliance can be especially tough in such volatile conditions—though in the U.S., only the largest banks are formally required to comply. Still, professional ALM practice means keeping IRR and CSR risks under control—regardless of regulation. Otherwise… well, we’ve seen what can happen (hello SVB from two years ago) 🫣. My recommendation to bank managers and ALM professionals: 1️⃣ Understand your interest rate and credit spread risk positions. 2️⃣ Simulate various shocks as recommended by IRRBB guidelines—and make sure your capital is sufficient. 3️⃣ Take into account current market developments, high volatility, and assess how to adjust your own business positions. I added two charts below: • U.S. Treasury yield curve changes over the past year - red curve was 6 months ago, now we see the blue line. Approx. 45 Bps on 30Y …. deduct approx. 12-13% from the price. • EUR/USD development over recent years (Sources: Trading Economics & World Government Bonds) #BankingIndustry #Banking #Bank #ALM #finances #markets #money #riskmanagement #interestRates #usd #bonds

The 10 Year U.S. Treasury Yield Is Repricing Risk Across Markets - Over the past week, the U.S. 10-Year Treasury Yield has remained elevated despite intermittent risk off sentiment. This is not a typical cycle driven move but a structural repricing of duration risk driven by inflation expectations, fiscal concerns, and weakening market liquidity. - Market risk is shifting. Duration is no longer a passive hedge. The correlation between equities and bonds has become unstable, with both declining simultaneously in recent sessions. Strong macro data continues to support a higher for longer narrative tied to the Federal Reserve, making yields highly sensitive to even small economic surprises. - At the same time, liquidity conditions are deteriorating. Weak Treasury auction demand, constrained dealer balance sheets, and reduced market depth are amplifying price movements. This creates a feedback loop where higher volatility reduces liquidity, which in turn pushes yields higher. - This convergence of market risk and liquidity risk is critical. It leads to higher volatility in benchmark rates, reduced hedging effectiveness, and increased probability of forced deleveraging across portfolios. - For risk managers, this environment requires a shift in approach. Duration assumptions must be recalibrated and historical correlations should not be relied upon. Liquidity adjusted risk metrics need to be incorporated alongside traditional models. Funding and collateral stress testing becomes essential as rising yields can trigger margin pressures. Monitoring Treasury market microstructure such as auction demand and dealer positioning is now key to identifying early signs of stress. Maintaining liquidity buffers and reducing leverage sensitivity is critical. - The key takeaway is clear. When the risk free rate becomes volatile, it changes the foundation of asset pricing across all markets. #MarketRisk #LiquidityRisk #FixedIncome #TreasuryYields #BondMarket #MacroEconomics #RiskManagement #FinancialMarkets #FederalReserve #Investing #InterestRates #PortfolioManagement #FinancialRisk