Widening Credit Spreads in Rarefied Territory

Regular readers know I follow the spread between Baa-rated bonds and Treasuries to get a feel for how much they are willing to accept risk.

Right now, it is not much.

Last week the spread widened to 340 basis points, a level seldom seen over the last 50 years.

Of course, we knew that already. The big questions are whether, how much, and how quickly the spreads will begin to narrow again. That will be the real signal from bondholders that the worst is behind us from the current crisis.

It is something of a double-edged sword. As long as the spread continues to widen, risky assets will perform poorly. However, the abnormally high risk premiums we are currently seeing indicate that longer-term investors will be paid more handsomely for accepting such risks than they have been paid on average in the past.

Comments

[whidbey:]

That is what the charts are saying anyway. But! Why would a longer-term investor wait for the putative higher returns? When the spread narrows it will likely be due to suspicion that CMT have increased in risk not the Corps have decreased. The credit of the US may no longer be the relevant reference point for prudent investors. Congress is planning to further debase the currency with a housing bail out which will be the mother of all debt. Your focus is too narrow.

2008 Mar 23 03:04 PM