Friday, May 1, 2009
Here's a nice recap of the state of credit spreads, as quoted on the iBoxx indices. These indices are the basis for the credit default swap spread on a basket of 125 investment grade entities and 100 non-investment grade entities, and thus they represent a good, liquid proxy for generic credit spreads on corporate bonds. As the charts show, spreads on investment grade as well as high-yield bonds have tightened significantly, though all spreads are still much higher than normal. One thing that stands out is the huge gap between IG and HY spreads (second chart): junk bonds are paying on average almost 10 percentage points more than high quality bonds, almost 5 times what might be considered "normal." The rally in corporate debt has been meaningful, but the potential is there for a whole lot more. At current levels, junk spreads are still anticipating a record-breaking rise in default rates. However, the market's default fears are being called into question daily, as we see more and more signs of an economy that is bottoming instead of sinking. The Fed's quantitative easing policy is also contributing to support the valuation of corporate bonds, since it significantly reduces the likelihood of deflation, which in turn is the worst nightmare for heavily indebted borrowers.
Full disclosure: I am long HYG, an exchange-traded fund designed to track the price and yield performance of the High-Yield iBoxx Index, at the time of this writing.
Posted by Scott Grannis at 4:22 PM