By Davide Barbuscia and Shankar Ramakrishnan

NEW YORK (Reuters) – U.S. corporate credit spreads have reached multi-year lows, reflecting increased investor confidence. However, some market participants worry investors might be overly optimistic given looming economic risks.

The spread on the ICE BofA U.S. Corporate Index, a widely used benchmark for high-grade debt, fell to 84 basis points this week, its lowest since 2005, down from 92 bps at the end of last month.

Spreads in the ICE BofA U.S. High Yield Index, which tracks junk bonds, decreased to 289 basis points late last week, marking the lowest level since March 2007, compared to 299 bps as of Thursday, according to LSEG data.

Spreads reflect the premium investors require to hold corporate bonds over safer government securities, serving as a measure of market confidence.

Strong demand for below-investment-grade bonds is perceived as a positive indicator, suggesting that investors find financial conditions healthy and are less concerned about corporate defaults.

> "The probability of any type of meaningful recession is quite low, and so that's very supportive of the credit asset class," said Steven Oh, global head of credit and fixed income and co-head of leveraged finance at PineBridge Investments.

Oh cautioned that there is a "level of complacency" in the market, as prices may not fully reflect the potential for steeper economic slowdowns.

> "Spreads are trading tight to where fair value is in a very supportive fundamental economic environment but one that is slowing," he added.

This month, Treasury yields have risen as fears over an economic slowdown eased after the Federal Reserve cut interest rates for the first time in four years and data indicated ongoing economic resilience.

Higher yields might prompt investors to increase their credit allocations, contributing to a rise in corporate debt demand witnessed in recent years.

Investment-grade bond issuance has reached $1.3 trillion this year, already 29% higher than the same period last year, according to Informa Global Markets data.

Additionally, as the Fed is expected to lower rates further, the risks around debt refinancing are diminished, improving the outlook for companies facing high borrowing costs, according to Dominic Pappalardo, chief multi-asset strategist at Morningstar.

> "Investors may be more willing to move down in quality and allocate to credit sectors instead of government bonds to ensure they reach their desired income goals," he suggested.

One potential obstacle could be the U.S. election on November 5, which might unsettle markets.

> "There always exists the possibility of conditions becoming more difficult in November," remarked Richard Wolff, head of U.S. bond syndicate at Societe Generale (OTC:SCGLY) CIB. He has been advising clients to advance their funding plans if possible.

Despite this, with yields around 7% for high-yield bonds, some market observers believe there is ample cushion to withstand a potential widening of spreads.

> "Junk credit spreads still have room to tighten, even though they are at their tightest levels in years," said Nick Burns, portfolio manager at Payden & Rygel.

> "Assuming flat rates, you’d need to see spreads widen materially or defaults increase substantially before realizing a negative return over a given twelve-month period with starting yields at that level,” Burns concluded.