Spreads and yields continue to decline

I've highlighted the predictive power of swap spreads many times so far, and it's been a month since I last featured this chart. Although the corporate bond market rally has been on hold for the past month, swap spreads have moved lower. 2-year swap spreads are almost back to their "normal" level of 30-40 bps. Yields on investment grade bonds have fallen dramatically from their high of almost 10% last October, to just over 6% today. Spreads on those same bonds are still unusually high, but that's mainly because Treasury yields are still amazingly low. The current yield on investment grade bonds is only 60 bps above the average of the past 5 years, so borrowing costs for most large corporations have come back down to pretty reasonable levels. Speculative-grade bond yields, as this chart shows, are way down from their highs but still extremely high; they need to fall a lot more before borrowing costs become reasonable for those folks.

This all adds up to some pretty impressive improvement on the margin, even if all is not yet back to normal. It would be nice if the Congress types would pay some attention to this good news. But if they did it might spoil their fun, because they love thinking that spending our money will be good for everyone.

With the Fed pledging today that the days of easy money will be with us for quite some time, it is reasonable to expect that money will find its way into the nooks and crannies of the economy and lubricate the wheels of commerce at least a little bit. Easy money will help offset the slump in demand, and likely keep default rates from rising as high as many still fear. Easy money is also a good antidote to the deflationary forces that the bond market still fears. Easy money is already at work in commodity land, helping to push most commodity prices up after their vertiginous plunge from July through late November. I think this adds up to a good case for liking high-yield and emerging market bonds.

Full disclosure: I am long HYG and EMD.