Credit Spread

Government bonds from countries like the United States or Germany are treated as benchmarks — assumed to carry minimal default risk. When a company issues a bond, it must offer a higher yield to attract buyers, because there is always some chance the company cannot repay. The gap between that corporate yield and the equivalent government yield is the credit spread. Suppose (as a hypothetical example) a 10-year U.S. Treasury yields 4% and a similarly dated corporate bond yields 6%; the credit spread is 2 percentage points, often expressed as 200 basis points (one basis point equals one-hundredth of a percentage point).

Credit spreads function as a real-time fear gauge for the economy. When investors grow nervous about corporate health or a potential recession, they sell corporate bonds and buy safer government debt — prices on corporate bonds fall, their yields rise, and spreads widen. In calm periods, spreads compress as investors chase higher returns and feel comfortable taking on risk. This behavior links closely to the concept of risk-on/risk-off sentiment in markets.

A common confusion: a wider spread does not always mean the corporate yield has risen. Sometimes the spread widens because the government benchmark yield has fallen sharply while the corporate yield barely moves. Traders typically watch the spread itself, not just the raw yield, for this reason. Spreads vary significantly across credit ratings; lower-rated bonds carry wider spreads to reflect their higher risk of default.