Credit markets signalling elevated market risk

Volatility and trading opportunities to pick up this fall

A sharp rebound in risk assets that started in late July fizzled out in the middle of the month. Low issuance and low engagement in a late summer market helped support both credit and equity markets. High yield spreads hit their lowest level of the year in late August, pushed tighter by a selloff in Treasuries without a commensurate selloff in high yield bonds.

The bounce in shares of mega cap technology companies did not pass through to credit markets, where project-level debt supported by leases from Magnificent Seven companies bounced modestly in early August before fading in the second half of the month and in many cases, making new lows in September.

With Treasury yields moving higher, we have taken our duration up modestly in recent weeks. We view Canada two-year bonds as an attractive cash substitute, with a yield of roughly 3.4% at the time of writing. This compares with the current Bank of Canada policy rate of 2.25%. Considering the state of the Canadian economy, particularly the Canadian real estate market, we believe that the Bank of Canada is unlikely to hike as much as is currently priced into the market.

Much of high-quality high yield has been driven to exceptionally tight spreads by the latest move higher in interest rates. We believe that the market risk is elevated today and are positioned accordingly. We expect that volatility and trading opportunities will pick up this fall.

Market outlook

High yield spreads hit a low of 260bp Govt OAS on Aug. 31, just 1bp away from the January 2025 low of 259bp, which was the lowest spread level since 2007. Much like both the 2025 and 2007 low in spreads, the bottom in spreads coincided with a spike in Treasury yields that took time to be transmitted to high yield prices. Unlike other major spread bottoms that coincide with decreasing credit spreads across the quality spectrum, CCC spreads have been moving wider for most of the past year and are currently at levels usually seen at periods of real market stress.

This degree of bifurcation in credit markets at a time where significant lows in risk premiums are being made at the index level is unprecedented as far as we can tell. The move in CCC spreads strongly suggests that defaults are likely to pick up at the lower end of the credit spectrum, and that access to capital is limited for overleveraged balance sheets.

Public markets won’t be the outlet for problem credits in private debt markets, where a default cycle is also likely to pick up. Finally, with generic spreads being as tight as they are while both CCC and data center risk premiums increase significantly, the spread compensation for owning high-quality high yield bonds is the lowest in decades. Much of the market that is currently priced as high quality includes small cap and cyclical credits that have melted up with the market.

We believe that the August low in spreads will likely be the low for the year, and that major bottoms in spreads often precede significant volatility episodes in the following six months. There are a number of building risks at the macro level, perhaps most importantly increasing Treasury yields, which should ultimately reprice all asset classes, especially those whose valuations are reliant on longer-dated cash flows.

With opportunities already increasing, we are optimistic that an extended period of low volatility is coming to an end.

Justin Jacobsen, CFA, is the Portfolio Manager of the Pender Alternative Absolute Return Fund at PenderFund Capital Management. Excerpted and updated from the Pender Alternative Absolute Return Fund Manager’s Commentary, August 2026. Used with permission.

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