A company that might not repay has to pay more than a government that will. The size of that extra payment is the market’s price on the chance of not being repaid, and it moves before most other stress signals do.

That lead is the reason this view sits on a macro dashboard rather than a fixed income one. Lenders reprice risk before shareholders do, and the sequence has held through most of the last few decades.

What it actually measures

Widening is the signal worth watching. Borrowers who could refinance comfortably last quarter finding it more expensive this quarter is the earliest reliable sign that conditions are turning.

The pace matters as much as the level. A gradual drift wider is the market repricing risk in an orderly way; a sharp move over a few days is a market that has stopped functioning normally, and the two mean very different things.

Very tight spreads mean risk is being priced cheaply. That supports asset prices while it lasts and leaves nothing in reserve when conditions change, because the compensation for taking the risk has already been given away.

Lenders reprice risk before shareholders do

Equity holders are exposed to disappointment and lenders are exposed to default, which is a harder and more immediate question. A firm that will merely underperform is a problem for its shareholders; a firm that might not repay is a problem for its lenders first.

That difference in exposure produces the difference in timing. Credit markets do the arithmetic on survival earlier, and their answer shows up in what borrowers are charged while equity prices are still being set by expectations about growth.

What it does not tell you

It measures corporate credit, which is not where every crisis starts. Stress originating in sovereign debt, currencies or banking plumbing can arrive without spreads having moved, and by the time it reaches corporate borrowers the warning value has gone.

The lead is a tendency, not a rule. Spreads have widened without an equity decline following, and equity declines have happened without spreads warning first.

Liquidity distorts the reading. Thin trading can move a spread without anybody’s view of default risk having changed, and holiday periods produce moves that reverse as soon as normal volume returns.

How to read it

Stress rising. The premium demanded of weaker borrowers is climbing.

Neutral. Credit markets are working normally.

Calm. Risk is priced cheaply, which is comfortable and leaves little cushion.

Head for the Macro dashboard, where Credit & Conditions sits with VIX Fear Gauge, Yield Curve and Economic Risk Index.

Common questions

What is the gap being measured here?

The extra yield a riskier borrower has to pay over a government borrowing for the same length of time. It is the price the market puts on not being repaid.

Why do spreads move before equities?

Because lenders face default and shareholders face disappointment. The harder question gets answered first, and the answer shows up in what borrowers are charged.

Should unusually cheap risk worry anyone?

They describe comfort rather than warn of trouble. Risk priced cheaply supports prices while it holds and leaves no margin for when conditions change.

Does a sharp move mean something different?

It does. A gradual widening is the market repricing risk; a violent one in days is the market ceasing to function normally, and the second is far more serious.

Does this catch every crisis?

No. Stress that begins in sovereign debt, currencies or the banking system can arrive with corporate spreads sitting still, and by the time it reaches corporate borrowers the early warning has already been spent.