Wednesday, June 22, 2022

Risk Premiums Still Low

Risk premiums are a common way to assess where we are in the economic cycle or, more accurately, where the market thinks we are.  Premiums bottom out when the economy is strong and top out at the bottom of a recession.  Right now, the spread between returns on high yield bonds and 10-year Treasurys is rising, but it is still very far from previous cycle highs.  Meaning, investors are still not worried about a significant recession that would lead to corporate bankruptcies.

The charts below from Yardeni Research make things quite clear: excluding the Great Debt Crisis of 2008-09 which saw spreads rocket to over 2000 bp (20%), spreads usually top out around 800-1000 bp (8-10%).  Today, spreads are still only at 500bp.

Another way to look at it is this: with junk bonds yielding just 8.45% and inflation at 8.60% a junk investor is not being compensated at all for assuming the extra credit risk.

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