The economic factors that influence corporate bond yields are interest rates, inflation, the yield curve and economic growth. All of these factors affect corporate bond yields and exert influence on each other. The pricing of corporate bond yields is a multivariable, dynamic process in which there are always competing pressures.
For example, economic growth is bullish for corporations as it leads to increased revenues and profits for companies, making it easier for them to borrow money and service debt, which leads to reduced risk of default and lower yields. However, extended periods of economic growth lead to inflation risk and upward pressure on wages. Economic growth leads to increased competition for labor and diminished excess capacity.
Higher wages begin to eat away at profit margins, making them more vulnerable to slippage in economic growth, and the inflation risk leads central banks to raise interest rates. When the risk-free rate of return rises, corporate bond yields must rise as well to compensate. The higher yields add to increased costs, creating even more vulnerability to economic stumbles.
Thus, yields can skyrocket as costs mount if the economy slips into a recession and revenues fall; investors begin to price in an increased chance of default. When growth concerns begin to dwarf inflationary risks, the central bank cuts interest rates, leading to downward pressure on corporate bond yields. Decreases in the risk-free rate of return make all yield-generating instruments more attractive.
The most bullish scenarios for corporate bonds are economic growth due to an increase in productivity, which does not spark inflation. In contrast, the most bearish scenario is a weak economy with inflationary risks that lead to high interest rates.
(For related reading, see "Investing in High-Yield Corporate Bonds.")