High Credit Spreads Show Modest Signs of Easing

Includes: DIA, QQQ, SPY
by: William Trent, CFA

The spread between the return on 10-year Treasuries and Baa-rated corporate bonds was 336 basis points last week. In historical terms, that is very high. In fact, the only times in the last 50 years that it was higher were the trough of the tech wreck and the 1982 recession/stagflation busting cycle.

High credit spreads make it harder for corporations to borrow and invest. As spreads widen, the economy tends to slow.

For investors, however, high spreads represent additional potential returns for a given unit of risk-taking. Peak levels of risk premia typically precede strong returns on risky assets - even if the strong returns are short-lived, as was the case in 2003.

Spreads have hooked down slightly as the credit woes that peaked following the Bear Stearns (NYSE:BSC) debacle may finally be stabilizing. Time will tell whether that was “the” peak or whether the current easing is simply a lull.