Blog — July 11, 2025

Credit markets shrug off uncertainty but need for hedging persists

"Markets hate uncertainty". This is taken as gospel and of course there is some truth to this statement. But the performance of the credit markets in recent weeks ahead of President Trump's July 8 tariff deadline suggests that the reality is somewhat nuanced. Policy uncertainty, as measured by the US Economic Policy Uncertainty Index (Baker, Bloom, Davis), reached record levels after "liberation day". While it has recovered over the last few weeks, it remains elevated.

Investment grade credit spreads, however, are now tighter than where they were on April 1. The CDX IG index (S&P Dow Jones Indices) is trading at 53bps compared to 61bps, and at a similar level to where we started the year. Sentiment was bullish in both IG and HY credit, underpinned by technical tailwinds, solid fundamentals in IG and better quality HY and an expectation that earnings would remain robust. 

Some may question if this will remain the case. Effective tariff rates in the US are now in the mid-teens and this is likely to impact growth. A degradation of credit metrics may follow as balance sheets weaken. Supporters of current spread levels would point to the balance sheet discipline shown by corporates and the flexibility most names have available to maintain IG ratings. All-in yields are still attractive and volatility - a key driver of spread direction - is relatively subdued. The Credit VIX on the CDX IG index is currently at 30bps, only slightly higher than year-end 2024 and significantly lower than the 92bps reached in April.

But if investors think spreads are too tight and the uncertainty isn't being priced into the market, what instruments do they have at their disposal to manage risks? Clearly credit managers strive to avoid the worst names that damage returns. But they can also access the near-guaranteed liquidity of the CDX and iTraxx indices to hedge. Options on the indices are also increasingly used to hedge risk in a more tailored fashion. Volumes in these instruments rose sharply in April and compared favourably to other products now touted as alternatives.

What may emerge in the medium term is a market akin to 2022-23. Then we saw - along side robust index volumes - a growth in CDS single names volumes as investors managed risk in sectors and individual credits impacted by higher rates and energy prices. In the present day, tariffs are also inflationary as the costs are passed on to the consumer. Liquidity in CDS single names -while not on the same levels as indices - is solid in IG index constituents and much of the HY universe. Ahead of the July 8 deadline, credit investors will no doubt be using all of the tools available to them. After all, the markets hate uncertainty.