I learned from a dear friend of mine who manages high yield at Dwight Asset Management (one of the largest fixed income management shops that you've never heard of), that with high yield bonds, spreads over Treasuries aren’t the most relevant measure for riskiness of the bonds. Because they are more equity-like, high yield bonds have intrinsic risk that is independent of the level of yields in high quality bonds, the leading example of which are Treasury bonds.
In general, Treasury bonds can be thought of as a default-free debt claim (not perfectly true, but people think so), while other bonds must carry a margin for default losses. As one moves down the credit spectrum, the riskiest corporate bonds act like equities, largely because as a company nears default, the equity of the firm is worthless, and true control of the firm is found in some part of the debt structure.
Spread curves of high yield bonds tend to invert when the Treasury yield curve is steeply sloped. The slope of the Treasury curve for that effect appears to be active now, particularly since high yield spreads have widened out from earlier in 2007. The effect can be seen though, in higher quality investment grade bonds. Given the lower spreads over Treasury yields on investment grade debt, the relative uncertainty in the present economic environment, and the lack of liquidity in the short end of the yield curve, it’s no surprise to find the spread curve inverted on agencies, and flattish, but still positively sloped for single-A and BBB corporates.
What this means is that there are intrinsic levels of risk affecting the yields on high quality corporate debt, lessening the positive slope of their spread curves, or with agencies inverting the spread curves. As the Treasury curve gets wider in 2008, those corporate spread curves should flatten, and then invert, unless more macroeconomic volatility leads to still wider credit spreads, or a rise in short term inflation expectations causes the yield curve to stop widening.
Another way to say it is that if the short end of the Treasury yield curve falls dramatically, don’t expect the yields on corporate debt to follow suit to anywhere near the same degree.