Tuesday, March 10, 2009

Credit remains tight; corporate spreads are elevated

Credit markets remain tight and corporate spreads are still at all-time highs.The chart illustrates monthly corporate spreads (measured by the Federal Reserve's Moody's seasoned Aaa and Baa yields) over the 10-yr Treasury since 1953 in basis points (bps), where basis point = yield/100. The Aaa and Baa spreads remain elevated and at record levels, or credit markets are still on red alert. Spreads generally rise during recessions with growing default risk, but current spreads are above what could be called a "recession average".

This is monthly data, and spreads started to tighten in February (see chart above). But now, corporate spreads are rising again

It is troubling for the macroeconomy that corporate spreads remain relatively unchanged from October 2008. The trend here is clear: corporate debt issuance is expensive, as the spreads to Treasuries remain wide. Until these levels fall back to the longer term average - the 2003-2007 average for Aaa is 113 bps and for Baa is 204 bps - firms will continue to scale back on debt-financed needs, i.e., investment.

According to the WSJ, markets await definitive government action:
After what seemed like the beginning of a thawing of debt markets early in the year, sentiment has deteriorated, analysts say. The markets remain open only to the strongest companies. A rally in U.S. Treasury bonds last week reflects another bout of flight-to-quality buying. Junk bonds now yield 19 percentage points more than safe Treasury bonds, up from a 16-point spread in February, according to Merrill Lynch. The spread is still narrower than the 21-percentage-point premium reached last December, but any widening shows investors are becoming more fearful.

Part of the problem is that investors are still waiting for key details from the government about its plans to bolster U.S. banks and unfreeze the credit markets. After launching a $1 trillion program to kick-start consumer lending last week, the Obama administration is considering creating multiple investment funds to purchase bad loans and other distressed assets. The intent of the funds is to stabilize the prices of good assets and restore investor confidence.

Without more clarity from the government on its bailout plans, the market could continue to drop, say analysts. That would further harm the economy and the institutions the government hopes to help, compounding its task of shoring up the financial system.
The economy remains in free fall. The labor market is contracting precipitously, consumer confidence is plummeting, home and equity values continue to crumble, and on top of that, the banks are insolvent. There's a long way to go on this one, and spreads will remain wide until signs of economic stabilization are evident.

Rebecca Wilder


  1. Contrary, to false belief, the monthly corporate spread over the 10-yr Treasury since 1953 does not reflect tight credit markets.

    From the last trough (2007-April), the Aaa-to-Tens spread hung slightly under 2% (200 BPS).

    At this time, the TENS yield hovered at 4.652% (2007-04-04) and hit a peak of 5.137% on 2007-07-11.

    Since then, a flight to TENS happened as Bernanke made cash and TENS substitutes, crashing the TENS yield.

    It's not that corporate debt has become expensive.

    Rather, it's that TENS has become amazingly cheap (2.828% on 2009-03-06), dropping 82% from peak to now.

    Looking further back, TENS yielded 6.435% on 1999-10-01, 7.827% on 1994-10-3 and a whopping 9.14% on 1988-10-3.

    Players have been forced to park their cash in what has become a conjured cash equivalent.

    Soon, this U.S. bonds bubble shall burst.

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