The Big Idea
This time is (not) different
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Spreads on risk assets keep tightening. Deal flow across corporate and structured credit keeps rising. The tone in conversations with investors is more bullish than not. It is tempting to see this as an extraordinary outcome in the aftermath of Fed tightening. But the broad pattern of spreads in risk assets through the last three tightening cycles have been roughly the same. Markets like tightening when it comes to an end.
Three cycles of Fed tightening make a thin foundation for any strong conclusions, but a least two features stand out in the hiking cycles this century under a Fed that has been far more transparent than its predecessors:
- Spreads on risk asset start and finish a hiking cycle in roughly the same place, maybe even biased to finish a few basis points tighter, and
- Spreads tighten after the last hike, or at least when the risk of further hikes ends
Cycle #1: 2004-2007
From the beginning to the end of Fed hiking from June 2004 to September 2007, spreads on risk assets started and finished in the same place. The option-adjusted spread on the Bloomberg US Aggregate fixed income index started on the day of the first hike at 48 bp and ended on the day of the last hike at 48 bp (Exhibit 1). In between, risk assets generally traded tighter. And after the last hike, risk assets traded tighter again for another six months until a new set of risks started to emerge—mortgage loans that started to default after just a few payments, declining home prices, the failure of New Century and other Alt-A mortgage originators in March 2007, the collapse of Bear Stearns hedge funds in the summer of 2007 and stress in commercial paper markets.
Exhibit 1: Spreads on risk assets during the 2004-2007 Fed hikes
Source: Bloomberg, Santander US Capital Markets
Cycle #2: 2015-2019
As the Fed hiked from December 2015 to December 2018, spreads on risk assets moved only slightly tighter. The OAS on the Bloomberg Aggregate started at 58 bp and finished at 51 bp (Exhibit 2). In between the first and last hike, spreads again generally traded tighter, widening only with the last two moves. And after the last hike, spreads again tightened as the Fed kept policy rates steady.
Exhibit 2: Spreads on risk assets during the 2015-2019 Fed hikes
Source: Bloomberg, Santander US Capital Markets
Cycle #3: 2022-today
The current cycle again shows spreads on risk assets roughly unchanged from start to finish. From the first hike in March 2022 to the last in July 2023, the OAS on the Bloomberg US Aggregate moved from 50 bp to 48 bp (Exhibit 3). Spreads traded wider more often than tighter while the Fed hikes. But since the Fed has finished—or more specifically, since the Fed in November clearly pivoted away from hiking further—spreads have traded tighter.
Exhibit 3: Spreads on risk assets during the 2022-2023 Fed hikes
Source: Bloomberg, Santander US Capital Markets
Reading history
There’s plenty of room for interpretation of these cycles. QT and changes in bank capital and liquidity rules have been in play through parts of these cycles. Interpretation also gets clouded by the changing composition of risk in the aggregate index. The mix of Treasury, MBS and corporate debt changes. The convexity of MBS shifts. The rating mix of outstanding corporate debt evolves. That even complicates comparison of spreads on the index over time. Of course, over the limited span of a hiking cycle those changes may be small.
The most meaningful conclusion may be that the tightening of spreads since November just means the current cycle is at least directionally just like its immediate predecessors. History repeats itself. The market sees the Fed as temporarily making policy restrictive but anticipates the next move as easing and broadly better for growth and credit. Spreads tighten in anticipation until new information suggests otherwise. Given the strength of most household and corporate balance sheets and the capital and liquidity in the financial sector, a domestic shift in risk trajectory looks unlikely. A three-legged history lesson says spreads can go tighter.
* * *
The view in rates
Fed funds futures for a third week price roughly 34 bp of easing this year as of the Friday close. The market-implied probability of cuts at different meetings also are roughly unchanged. The market sees a 50% chance of September and a 60% chance of December. It’s still all about sticky inflation. In the aftermath of the last FOMC, implied rate volatility continues to drop and is near the lowest level of the year.
Other key market levels:
- Fed RRP balances closed Friday at $449 billion, down $37 billion in the last week. RRP balances have bounced between $400 billion and $500 billion since the start of March. That range has held despite yields on most Treasury bills running well above the RRP’s 5.30% rate.
- Setting on 3-month term SOFR closed Friday at 533 bp, unchanged on the week
- Further out the curve, the 2-year note closed Friday near 4.82%, down 5 bp this week. The 10-year note closed at 4.42%, down 8 bp this week.
- The Treasury yield curve closed Friday afternoon with 2s10s at -40, flatter by 3 bp this week. The 5s30s closed Friday at 11 bp, flatter by 2 bp over the same period.
- Breakeven 10-year inflation traded Friday at 233 bp, down 3 bp this week. The 10-year real rate finished the week at 210 bp, down 5 bp this week.
The view in spreads
Falling implied volatility should create more room for spreads in all risk assets to tighten a little further. Credit still has the most momentum with a strong bid from insurers and mutual funds, the former often funded with annuities and the later getting strong inflows in 2024. The broad trend to higher Treasury supply also helps in the background to squeeze the spread between risk and riskless.
The Bloomberg US investment grade corporate bond index OAS closed Friday at 87 bp, unchanged this week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 140 bp, tighter by 2 bp this week. Par 30-year MBS TOAS closed Friday at 35 bp, joining the parade of metrics unchanged tighter by 8 bp this week. Both nominal and option-adjusted spreads on MBS look rich. Fair value in MBS is likely closer to 70 bp in OAS, so widening toward fair value looks reasonable.
The view in credit
Higher interest rate should raise concerns about the credit quality of the most leveraged corporate balance sheets and commercial office properties. Most investment grade corporate and most consumer sheets have fixed-rate funding and look relatively well protected against higher interest rates—even if Fed easing comes late this year. Healthy stocks of cash and liquid assets also allow these balance sheets to absorb a moderate squeeze on income. Consumer balance sheets also benefit from record levels of home equity and steady gains in real income. Consumer delinquencies show no clear signs of stress, with most metrics renormalizing back to late 2019 levels. Less than 7% of investment grade debt matures in 2024, so those balance sheets have some time. But other parts of the market funded with floating debt continue to look vulnerable. Leveraged and middle market balance sheets are vulnerable. At this point, mainly ‘B-‘ loans show clear signs of cash burn. Commercial office real estate looks weak along with its mortgage debt. Credit backing public securities is showing more stress than comparable credit on bank balance sheets. As for the consumer, subprime auto borrowers and younger households borrowing on credit cards, among others, are starting to show some cracks with delinquencies rising quickly. The resumption of payments on government student loans should add to consumer credit pressure.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
