The bond boom seems endless, but behind the optimism lurks an invisible threat. When the risk premium disappears, true risk begins to build.
I’ll tell you something no one’s telling you right now. The lower the risk premium for investing in bonds, the higher the risk of investing in bonds. It seems like a paradox, right? Yet, if we look at the history of bond markets, it is precisely in these moments of apparent euphoria that the foundations for the most painful corrections lie.
In recent years, investors have rediscovered the allure of fixed income. After a decade of negative rates, yields back in the 4–5% range have triggered massive inflows into government and corporate bonds, almost as if a golden age had returned. But the debt market, by its very nature, is cyclical. And if history teaches us anything, it’s that phases of extreme strength in real yields and spreads alternate with phases of "extreme negatives," often sudden and brutal.
Today, we may be precisely at that point of maximum optimism, where perceived risk is at its lowest and reality, perhaps, is preparing to surprise.
Yield curve spreads: the hidden signal
Apparently, developed economies are experiencing a slight steepening of the yield curve. Central banks are gradually lowering short-term policy rates. However, long-term yields remain elevated, signaling that the market isn’t convinced that disinflation will be sustained.
In technical terms, a curve that slopes upward again indicates rising inflation expectations. This isn’t necessarily a sign of crisis, but a clear message: investors are demanding a positive real premium to hold government bonds.
Translated: no one wants to lend money long-term without being compensated by the risk that, in the future, the real value of that money will erode. In other words, the market is implicitly saying that inflation isn’t fully under control."
This condition represents a "silver lining": an apparent normality in yields that, however, masks the latent fear of a return to inflation. Historically, similar patterns have occurred before cyclical reversals or tensions in the credit markets.
Sovereign Spreads: The False Optimism Around Italian BTPs
Another little-discussed signal concerns the sovereign spread. The BTP is a prime example. When we read that the yield spread between Italian BTPs and German Bunds has fallen below 80 basis points, the instinctive reaction is positive: "Good, Italy is perceived as less risky."
But the reality is more complex. An excessive narrowing of sovereign spreads does not always indicate a structural improvement in a country’s creditworthiness. It could, instead, reflect excessive market confidence.
Let’s ask ourselves: has Italy’s debt-to-GDP ratio improved enough to justify a spread similar to the French one? The answer is no. The narrowing of the spread signals an extreme compression of risk premia, a state of complacency that rarely lasts long.
In past cycles, when spreads reached such compressed levels, a small shock—political, fiscal, or external—was enough to cause them to explode again. It’s the typical "confidence bubble" that precedes phases of stress.
In short: the lower the perceived risk seems, the greater the real risk.
Spreads across rating categories: the most dangerous signal
Perhaps the most disturbing data comes from the corporate world. Spreads between investment-grade and speculative-grade bonds are at their lowest levels in the last ten years. Similarly, the spread between high-quality government bonds and corporate bonds is extremely tight.
In essence, the market is saying that the risk of lending to a company with a "junk" rating is similar to the risk of lending to a solid company. This is a classic symptom of phases of credit euphoria.
When perceived risk becomes too low, investors stop distinguishing between good and bad borrowers. But credit’s cyclical nature is a constant: when optimism is excessive, repricing is often violent.
In terms of cyclical analysis, the credit spreads typically widen as liquidity tightens: it narrows when the economy grows and widens when signs of stress emerge. Today, we are in full compression.
“Expect the unexpected”
And here comes the less obvious part. All this technical and cyclical analysis only explains what happened in the past, but it cannot tell us what will happen tomorrow.
If spreads are so low today, it’s also because the market isn’t pricing in higher default rates: as long as the default rate remains low, spreads can remain compressed for a long time. In a certain sense, the market tends to create self-fulfilling dynamics as long as conditions remain favorable.
History teaches us, however, that equilibrium is fragile. Statistics can lose their predictive value when the structural environment changes: if real rates remain positive and bond demand remains high, even low spreads could persist longer than expected.
But precisely for this reason, it’s crucial to remember an unwritten market rule: when everyone is on the same side, risk doesn’t disappear, it merely changes form.
Original article published on Money.it Italy 2025-11-10 07:51:00. Original title: Una bomba finanziaria sta per esplodere nel mercato delle obbligazioni?
