This article was published on May 21, 2026 at 17:57 on Signal, the capital markets compass.
Despite a sharp rise in interest rates, the credit spread between government bonds and corporate bonds has narrowed. As absolute yield levels have risen, carry demand seeking higher yields has flowed in, but the additional compensation offered by corporate bonds over government bonds is shrinking, prompting calls for a selective approach.
According to the financial investment industry on the 21st, the credit spread between AA- rated three-year corporate bonds and three-year government bonds stood at 61.3 basis points (1 bp = 0.01 percentage point) as of the 20th. After widening to 66.8 bp last month, the gap has gradually narrowed. Despite caution over rising benchmark rates, investor demand to lock in interest income since mid-last month is seen as having driven the spread tighter.
Some in the market are concerned about the pace of the spread compression. With government bond yields rising and credit spreads narrowing simultaneously, the "Yield Ratio" — an indicator showing the relative yield of credit bonds versus government bonds — has fallen to near this year's low. The ratio is calculated by dividing the credit bond yield by the yield on a government bond of the same maturity; a lower figure means credit bonds offer less additional yield appeal versus government bonds.
Kim Sang-in, an analyst at Shinhan Securities, said, "There have been cases in past rate-hike cycles where the Yield Ratio declined." He added, "Currently, with high oil prices stemming from the Middle East and a semiconductor super-cycle acting as compound fundamental factors on both sides, the surge in rates has not spilled over into credit risk, while solid carry demand has driven the Yield Ratio lower."
In particular, the diminishing absolute-yield appeal of credit bonds appears to be driving the spread compression. From an investor's standpoint, prime credit yields of around 4% remain attractive, but with government bond yields rising in tandem, the excess compensation for taking on credit risk has shrunk compared with the past. If higher rates persist, this trend could rebound on companies in the form of heavier funding costs.
The likelihood of differentiation by credit rating is also rising. Top-rated firms can sustain favorable funding conditions on the back of stable carry demand, while lower-rated firms may face heavier refinancing burdens as higher rates combine with weaker investor sentiment. Many observers say polarization could deepen, with investor demand diverging based on book-building results, rating outlooks and maturity profiles.
Indeed, companies that conducted corporate bond book-building this week saw demand vary by credit rating. LG Electronics drew 2.25 trillion won in valid orders against a 250 billion won offering in its book-building on the 19th. Specifically, the two-year tranche of 150 billion won attracted 1.17 trillion won, the five-year tranche of 50 billion won drew 750 billion won, and the 10-year tranche of 50 billion won received 330 billion won. LG Electronics' corporate bond credit rating is AA, classified as prime grade.
By contrast, Dongwha Enterprise, rated BBB+, saw its entire 40 billion won corporate bond offering go unsold in book-building on the same day. Dongwha offered a fixed coupon of 6.50%, while the yield on 18-month BBB+ corporate bonds stood at around 6.084% as of the day.
