Key Questions: Do Cracks in the Credit Markets Mean US Corporates’ Financial Health Has Cracked? 

In times of macroeconomic uncertainty, equity and fixed-income investors look to the credit markets for indications of economic deterioration and company distress. As of this writing (April 7, 2025), equity and credit markets have continued their sell-offs associated with President Donald Trump's April 2 tariff policies. But specifically within credit markets:

• U.S. investment-grade and high-yield corporate credit spreads (the risk premium over a risk-free instrument, or the extra compensation investors seek to earn by assuming greater risk) increased by more than 15 basis points and 90 basis points, respectively; and 
• Investment-grade and high-yield credit default swap spreads (common credit risk measurement) spiked by at least 10 basis points and 50 basis points, respectively

Note: One basis point equals 0.01%.

Make no mistake, these are large spread movements over a short period of time, and they understandably cause some to wonder whether a wave of company distress or defaults may be imminent. In our opinion, we do not believe that will be the case.

While the road will be bumpy for the foreseeable future, we believe that recent credit market moves are more indicative of a market recalibration rather than corporate stress, as corporate bonds have traded at very expensive valuations in recent years and are now trending back to normal prices. As we lay out below, at this point in time, we believe that most U.S. companies will be able to weather volatile market conditions and a weaker economic backdrop.

Growing Risks 

Although current “hard” economic data point to a still-resilient U.S. economy, investors and corporations are concerned that President Trump’s tariff policy and a global trade war will lead to an increase in inflation and a slowdown in economic growth, if not a recession. And if such a scenario materializes, then companies’ financial health will deteriorate. Already, companies are revising their annual guidance lower, and “soft” economic data are pointing to a weaker and more negative consumer. Yet, even with these growing risks, companies today will still have sufficient runway and tools that they can deploy before they will feel the bite meaningfully.

Strong Balance Sheets and Discipline 

Corporate firms entered 2025 with strong balance sheets and sounds capital discipline. In the past few quarterly earnings results, U.S. corporates’ “health” metrics have been on a positive trend. For instance, on average, companies had improved revenue growth and solid profit margins, which have allowed them to strengthen their balance sheets. Furthermore, companies had moderated their borrowing, repaid some debt balances, and reduced shareholder payouts in proportion to their earnings. Such actions thus speak to management teams’ conservatism and discipline with cash utilization in the face of an uncertain environment. 

If we go down the credit risk spectrum and look at high-yield companies, which have the weakest fundamentals and highest default risks, we also see similar trends as mentioned above. High-yield companies’ profit margins have been relatively stable, and debt burdens have decreased and are multiples below what they were during the COVID-19 pandemic and 2008’s Great Financial Crisis (GFC).

Indeed, we see this relative strength via well-behaved default rates as well. As of the end of February 2025, US high-yield default rates were only 6.08%, while during the COVID-19 pandemic and GFC, default rates spiked to about 8% and 13% respectively.¹  While default rates may pick up if the current softening environment persists, we do not expect default rates to reach to pandemic and GFC levels given companies’ current balance sheet strength and low imminent debt repayments. 

Mitigation Tools

In addition to being on a stronger footing, companies also have tools at their disposal to limit tariff-related risks. For example, firms may be able to pass on some of the tariff costs to customers to protect profit margins, and we have seen them successfully do so under President Trump’s first-term tariffs regime; profit margins during that period were either flat or expanded, albeit at the cost of sales growth. Another tool that firms have is a more flexible supply chain. In recent years, U.S. companies have already restructured (or are in the process of restructuring) their supply chains such that production can be more localized or flexibly shifted to other locations. With this flexibility, companies are thus able to mitigate some of the tariff costs.

Reminders

With all that said, it is worth remembering two points:

1. U.S. policies are subject to change
2. Not all companies will survive

On point one, monetary, fiscal, and trade policies can change, and any changes can alter the impacts of the current tariffs policy. For instance, the Federal Reserve may lower interest rates, which could provide economic support. On the other hand, tariffs may be raised further and accelerate economic deterioration. At this time, it is unclear whether there will be any policy changes and if they will be a continued headwind or offsetting tailwind to current conditions. 

On point two, although corporate firms on average are coming from a place of strength and have levers to pull, there will inevitably be some that are inadequately prepared. For the reasons mentioned above, we expect investment-grade and some high-yield firms to be able to absorb the current growing risks, while the lowest-rated rungs of the high-yield ladder may feel the most pressure. With these points in mind, we do not expect a wave of corporate distress and defaults but will continue to monitor closely corporates’ financial health. 

Last, as the current environment remains fluid and policies can be subject to quick changes, we believe security selection is more important than ever to weather the volatility. 

For more information, please contact your advisor.