The quality of the global high-grade credit market hasn’t been this good since the early stages of the easy money era.

Safe single A bonds are close to becoming the biggest part of investment grade indexes for the first time in about 10 years. At the same time, there are fewer risky bonds in the group. That means investors are buying a higher-quality basket overall, and supports the view of some market participants that valuations aren’t as stretched as they seem.

“Rating agencies are following the debt ratios of the companies, which appear to be getting better. And, of course, this makes this spread look quite reasonable,” said Thomas Neuhold, who is responsible for fund management at Gutmann Kapitalanlage AG. “We can go a little tighter as long as there is support, such as from lower rates by central banks,” he said.

The extra compensation investors get for lending to global investment-grade companies instead of the government has fallen to its lowest in two years, according to an index run by ICE. But the quality of the index has improved markedly: the last time spreads were at this level, bonds from firms rated triple B accounted for more than half of the group.

The shift to safety is the opposite of what happened during the ultra-low interest rate era, when the cost of borrowing fell so much that even the most precarious firms binged on new debt. While the legacy of that spree is still weighing on certain parts of the market, such as real estate, the overall trend in recent years has been a recovery in credit ratings.

This year is shaping up to be the fourth in a row when major rating companies announce more upgrades than downgrades among high-grade firms, based on data compiled by Bloomberg.

Meanwhile, traders are no longer so concerned about a major recession amid still-high borrowing costs, while falling inflation rates are expected to prompt central banks to cut interest rates later this year.

“The backdrop of a seemingly perfect soft landing, weak growth and falling inflation combined with rate cuts is providing a lot of support,” said Mark Benstead, a senior portfolio manager at Legal & General Investment Management. Investors’ desire to put their money to work can also “keep driving quality credit tighter.”

Deutsche Bank AG credit strategists agree. “The signal of central bank rate cuts is boosting animal spirits, but there is scope for euphoria to build via wealth effects once these cuts are confirmed,” according to Steve Caprio and Karthik Nagalingam. They revised their spread targets tighter in a note on Monday.

To be sure, improved quality in high-grade indexes doesn’t mean that risks have disappeared. Uncertainty abounds for the year ahead, with elections coming up, wars ongoing and the timing of rate cuts still unclear. And Ella Hoxha, Newton Investment Management’s head of fixed income, said that while company balance sheets have generally improved, “risks have been transfered more to the public sector.”

Still, the overriding factor determining spreads is likely to be the persistent demand for bonds from cash-drenched portfolio managers, known as “technicals” in market parlance.

“We have been through periods when spreads were tight and valuations were stretched, particularly in the pre-pandemic years,” said James Vokins, global head of investment-grade credit at Aviva Investors. “We can stay at tight valuations for a long time as long as those technicals remain.”

This article was provided by Bloomberg News.