A bond spread is the difference in yield between two bonds, typically expressed in basis points (where 1 basis point equals 0.01%). It measures the additional return an investor earns from one bond compared to another, usually a risk-free government bond with a similar maturity date.
Bond spreads reflect credit risk and market conditions. A wider spread means investors are demanding higher compensation for taking on additional risk—for example, lending to a corporation rather than the government. Bonds from riskier issuers have wider spreads. A narrower spread suggests investors perceive lower risk and greater confidence in the borrower's ability to repay.
Spreads change with market sentiment. A widening spread can signal economic uncertainty or concerns about a bond issuer's financial health. A narrowing spread typically signals confidence in the economy or improved financial conditions for that issuer. This makes bond spreads useful as an indicator of both credit risk and overall market sentiment.
For traders, bond spreads have practical limitations. Comparisons between different bonds can be difficult because spreads vary based on maturity, credit quality, and liquidity. Market sentiment can shift quickly, making past spread levels unreliable as predictors. Interpretation requires understanding multiple factors beyond the raw yield difference.
