From the Desk

Global bond buyers want some governments to balance their books. After years of running fiscal deficits and piling up debt, markets are now demanding more accountability. While promises of generous spending have impressed voters, lenders want more fiscal discipline. And rising sovereign bond rates are reflecting that concern.     

Last October, a U.K. fiscal budget that was heavier on perks than initially expected roiled markets. Yields on 10-year bonds shot up and continue to move higher. France’s inability to balance its budget and veering into a political crisis have driven its borrowing costs well above its European peers. The U.S. is receiving some of that same scrutiny. Concerns that deficits could continue to swell have seen bond rates pop up. Debt-to-GDP ratios for all three of these countries is either at or above 100%. Now, none of these nations are likely to see a bond buyer’s strike. But through higher rates, markets are enforcing their view that they want to see more belt tightening. 

Since 2008, when the great financial crisis hit, central banks embraced broad bond buying. That gave them an oversized influence on debt markets. Now that they are pulling back, yield driven investors are having more of a say. And that oversight should force policymakers to prioritize fiscal accountability. 

Sources: Bloomberg, Financial Times, 2025.

As the new year begins, the option-adjusted spread (OAS) on the investment grade corporate bond index has been mildly wider, at 82 basis points (bps), than its recent tight spread of 74 bps. For context, the last time this index traded in the 70s was March of 2005 at 77 bps. At 74 bps, the index was at its tightest level since 1997, when the OAS was at 51 bps. 

There are plenty of factors that can affect credit spreads. The most significant one should be, hopefully, the credit quality of the underlying issuers. However, that’s not always the case, a fact that keeps asset managers like us in business.

Underlying credit quality matters, but the stability of that credit quality is just as important. We’ve discussed this concept in the past, but it is worth restating since we believe it’s having an impact on spreads in this environment. Notwithstanding absolute credit quality, the stability of that credit quality actually matters more, according to our analysis. For example, take a given BBB-rated issuer that has been BBB for a long time, has a clear corporate policy to manage the company with that rating (as per its leverage levels) and is expected to have the operational ability to do so. Such an issuer will trade at a tighter spread than other companies with more ratings volatility that may have the same credit rating. 

Carry this forward to the wider market and this concept has been a driver of tighter credit spreads. Ratings volatility has fallen, and with it credit spreads. Add to this a too-healthy equity market and absolute yields high enough to pull in buyers, and the OAS on the corporate bond index touches the 70s. We still believe spreads can stay tight given this fundamental backdrop, but equity volatility or rate volatility are at the top of the list of what we think can drive spreads wider.

Source: Bloomberg, 2025.

The investment grade private credit market has changed a lot over the past two decades. One significant change is that the agents bringing deals to the syndicated market seem to have fewer resources than they used to. We see this frequently in the lack of offering memorandums. While financials, draft legal documents, roadshow presentations and interactions with management teams remain available to analysts and fundamental to underwriting, those old offering memorandums really dug into the industry and nuts and bolts of the prospective borrower. 

To have the same comfort level on a prospective credit today, it is essential to have a team that has the depth and breadth to specialize in a given sector. Currently, the information you used to rely on to understand the industry and credit is already contained in the analyst team underwriting the credit. For larger shops, they probably aren’t missing too much – having teams dedicated to infrastructure, structured credit, financials, transportation, etc. offers the ability for the team to constantly be researching a given sector. More complex industries would likely be harder to fully underwrite in smaller shops.

What does a second Donald Trump presidency mean for the energy transition? Much of the market analysis has focused on guessing what parts of the Inflation Reduction Act (IRA) remain in place or get repealed. 

A starting point would be to pay attention to interest rates. Eleven U.S. Federal Reserve rate hikes from 2022 through 2023 created a headwind for renewable energy, even with the IRA’s supportive policies. Lifetime costs for solar and wind power are concentrated in the front end due to their capital-intensive nature, while oil and gas infrastructure is more distributed. As a result, interest rates play a much bigger role in changing the profitability of renewables. A Wood Mackenzie analysis found that a 2% increase in the risk-free rate pushed up the levelized cost of electricity by 20% – compared to 11% for a combined cycle gas plant. The recent reversal of Fed rate cuts are expected to alleviate some of these pressures we have seen in the market.  

Last year, as of September 2024 solar and wind made up 89% of new generating capacity in the U.S. As a share of electricity generation though, renewables are still roughly half that of natural gas. Advancements in battery energy storage systems are expected to further enhance the renewables market by providing critical grid stability and enabling better integration of intermittent energy sources.

President-elect Trump has made no secret of his opposition to wind power. At a press conference this week he stated, “We're going to try and have a policy where no windmills are being built." Whether policy will be implemented to actively discourage renewables, as opposed to simply incentivizing fossil fuels, remains to be seen. But the pace and direction of interest rate changes will likely be a significant factor on where the U.S. energy transition sits in four years.

Sources: Energy Information Agency, Wood Mackenzie, Federal Energy Regulatory Commission, CNBC, 2025.