The credit spread, a key liquidity and macro economic indicator that represents the difference in yield between high-risk junk bonds and the low-risk 10-year treasury bond, is once again below the critical 3 percent mark. "They're overlooking the risk."
In the May 2008 issue of Fortune magazine, Harvard trained economist Geoff Colvin wrote that June 13, 2007 was the day that the markets "rediscovered risk." June 13th was notable as the day that years of excess liquidity, which had fueled a cavalier attitude toward risk taking, rapidly began to dry up spawning the largest credit crisis since the Great Depression.
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Narrowing of credit spread indicates the relationship between price and risk of low-risk government bonds and high-risk junk bonds is once again reaching pre-credit crisis levels.
The credit spread, the yield difference between low risk 10-year U.S. treasury bonds and high risk junk bonds, narrowed to below the critical 3.0 percent mark last Thursday to close at 2.978 percent, according to yield benchmarks tracked by CreditPulse. The credit spread has now reached its lowest level since 2007, the year before the credit crisis.
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The credit spread represents the difference in yields between high-risk junk-rated bonds and low-risk U.S. government bonds. When credit markets are liquid the spread narrows, when credit markets are tight the spread widens. The credit spread is a key indicator of the integrity of credit markets. CP tracks the credit spread bi-monthly using data published in the Wall Street Journal. As of Oct. 23rd, the credit spread stands at 5.487%.
