Bond navigators: Beware the narrative

In a recent meeting I was asked if I was still positive about sterling credit compared to government bonds, given that ‘spreads are tight’.

It’s true, spreads are tight. Depending on which index you look at, sterling credit spreads* are at 77bps*, roughly half the level seen three years ago. That spread tightening has been a useful kicker to performance, but to focus on what spreads are at misses bigger questions: why are spreads at these levels, and how much does it matter.

It sounds obvious, but spreads are tight because credit is attractive. Defaults are low, company balance sheets are generally healthy, and investors have been buying credit because of attractive yields. What would drive spreads higher? A reversal of one or more of those things.

Does it matter?

Of course spreads matter – it is the additional yield you’re getting for credit risk. But even at these tight levels, I think you are still being over-compensated for default risk. More importantly, spread is just part of total yield. Fixed income has historically been an income asset, and right now the yield on sterling credit is pretty attractive at around 5.3%.

When it comes to performance, holding government bonds is not a ‘risk free’ strategy. At the start of this year, many investors were favouring government bonds over credit – driven by the ‘spreads are tight’ narrative. Spreads haven’t really moved this year, and hence the 2025 return was just under 7%, compared to 5% for gilts**. That ‘risk free’ approach cost you quite a lot.

Can this continue in 2026?

We could see spreads widen, if economic news deteriorates and therefore perceived default risk increases. But that scenario also probably sees government bond yields decrease. Either way, with the level of carry currently available to credit investors, you are at least being paid a nice yield while this plays out, and the impact of any spread weakening is outweighed or mitigated by that carry.

* Sterling credit spread at end of 2025 based on iBoxx Sterling Non-Gilt All Maturities index

**Gilt return for 2025 taken from FTSE Actuaries UK Conventional Gilts All-Stocks index. Sterling credit return based on iBoxx Sterling Non-Gilt All Maturities index. Source: RLAM.

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