Crisis forgotten in bond-buying frenzy

April 2, 2010

Lenders do not seem to be good learners. To judge from the credit market, the 2008-9 crisis might never have happened. Perhaps this is the healthy fading of traumatic memories, but the current buying frenzy looks more like a return to an old bad habit.

It’s hard to find debt that investors don’t like. They are snapping up paper from solidly rated companies such as Wal-Mart and Anheuser-Busch InBev, and from still bankrupt Lyondell Chemical. The enthusiasm has reduced the spread on bonds dramatically.

In the panic-stricken days of March 2009, investment-grade U.S. corporate debt yielded 5.4 percentage points more than U.S. Treasuries. That spread is now just 1.5 percentage points, according to Barclays Capital. For junk bonds, the spread has declined from 17 to 6 percentage points.

The combination of thin risk premiums and the Federal Reserve’s near-zero overnight interest rates makes for unimpressive yields. Barclays clocks the average yield on high-grade bonds at 4.5 percent, which is two percentage points below the 20-year average.

Even traders should be wary. The Fed’s statement that the rate policy would remain for an “extended period” could disappear as soon as April 28. Even a nuanced shift in the direction of higher rates would end the game of ultra-easy money, pushing up Treasury yields in anticipation of a rate hike.

There would be some compensation. Since the Fed will move when the economy looks stronger, risk premiums would be apt to narrow further. But from the current levels, there’s not that much juice left for investors. The spread on investment-grade corporate debt now is just 20 basis points above its long-term average.

And suppose the Fed move does not presage a strong economic recovery. Then the current yields would look like a sucker’s bet.


$1.3 trillion left money market funds and into equities and bonds last week

Posted by love91 | Report as abusive

People don’t understand how bonds work. It is too abstract. Tell us about:

1.Coupon/face value;
2.Why there are actually returns as the trade
values/units are so high, so the interest is high;
3.The Fisher-effect – nominal less inflation = real
4.Rates: downward and upward sloping;
5.The yield curve;
6.Types of bonds;
7.Context of bonds;
8.The inverse relationship between share/stock and bond prices.

Posted by Ghandiolfini | Report as abusive

…9. Before and after tax effects, compared to dividends and capital growth;
10. Inverse relationship between rates and bond prices.

& 100 year graphs, please !

Posted by Ghandiolfini | Report as abusive

…and how it is used in the Worldwide carry trade (parities) and currencies to create liquity ?

Posted by Ghandiolfini | Report as abusive

There is too much cash flying around the world looking for places to invest

Posted by love91 | Report as abusive

too much cash flying around the world is going to spur inflation

Posted by love91 | Report as abusive

The surging cash around the world will spur inflation at some point

Posted by love91 | Report as abusive

“Lenders do not seem to be good learners. To judge from the credit market, the 2008-9 crisis might never have happened.”

… They learned that the Federal Government will bail them out, so why should they bother making sensible loans?

Posted by jollypants | Report as abusive

Bonds are easy: Strong economic growth, central bank raises rates, bond prices fall due to selling by investors and yields rise. Weak economic growth, central bank cuts rates, bond prices rise due to buying by investors and yields fall.
Bond prices are based on a spread over benchmark government bonds in the same term. That spread is added to the yield on gov’t bonds and, given the coupon and maturity date, worked backwards on the bond in question to determine its price.
Bonds priced above par have a yield lower than the coupon, bonds priced below par have a yield above the coupon.
Next question?

Posted by Gotthardbahn | Report as abusive

Wrong. Bonds only look easy. You seem to be focused only on government bonds. What we have now seen is that risk assessments on corporates are meaningless, and that you can leverage bonds in creative ways that we haven’t recently in equities. The basic components of business ARE simple, it’s the different way those components get sliced and diced that make life complex. Also, in the end, everything is positively (and, it seems, strongly and surprisingly) correlated.

My kingdom for some accurate implied volatility data.

Posted by ARJTurgot | Report as abusive

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