Credit Markets . . . Bearish Is As Bearish Does

Conclusion: The TED SPREAD and junk bond yields are pointed up and to the right.  That’s bearish for equities.


Despite the bounce in equities over the past week, debt markets continue to flash bearish signals as spreads widen and bond prices hit new lows.  Below we’ve outlined a chart of high yield bond yields in the United States and the Ted Spread, both going back three months.   Admittedly,  high yield bond yields and the ted spread both measure slightly different types of risk.


The Ted Spread  is the difference between the interest rates on interbank loans and short term U.S. government debt, and is an acronym formed from T-Bill and Ed (the ticker symbol for the Eurodollar futures contract).  A typical range for the Ted Spread is between 10 and 50 basis points.  Obviously, a widening Ted Spread means that liquidity is being withdrawn and perceived credit risk, generally, is going up.  During the 2007 subprime mortgage crisis, the Ted Spread was routinely in the 150 – 200 basis points region.


Currently the Ted Spread is at 47 basis points, which is up 5 basis points week-over-week.  While this is not flashing an extreme, it is certainly at the high end of its normal range and climbing.  For the equity market to continue to rally, we will likely need to see the Ted Spread narrow.


In conjunction with the widening of the Ted Spread, high yield bond yields in the U.S. have been climbing over the course of the past few months.  As we wrote on May 7th:


“Credit spreads widening in conjunction with a declining stock market typically indicate a dramatic shift away from any type of risk by institutional investors.  More specifically, they also signal bond investors getting increasingly concerned about fundamentals and cash flow.   Over the course of the past few days, corporate high yield yields widened dramatically from 8.2% to 8.6%.  This morning yields continue to climb.”


This dramatic widening of junk bond yields was obviously a precursor to the equity market sell-off, and indicative of less certainty related to specific company cash flows and their ability to refinance at comparable rates.  In Europe, there hasn’t been a high yield bond offering in over a month, although there are a number of offerings on the docket for this week.  The success of these offerings will be an important indicator for the health of debt markets in Europe.


As ever, the credit markets are leading indicators for equity markets.


Daryl G. Jones
Managing Director


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