High Yield Spreads: No Slowdown in Sight

If you're looking for signs of stabilization in the credit markets, the high yield market is not a good place to start.  Based on data from Merrill Lynch, high yield bonds are yielding nearly 1,800 basis points more than comparable Treasuries.  In the last month alone, spreads have risen by more than 200 basis points, and since bottoming in the Summer of 2007 at 241 basis points, they are up 645%.  To put this in perspective, with the 10-Year US Treasury now yielding 3.4%, a high-yield borrower would need to pay roughly 21.4% per year to take out a ten-year loan.  With terms like these, who needs loan sharks?

 

Comments

[dj]

Well C.D.B.'s are the place to be, if you have balls made of steel

[J Edward]

The best way to describe money in the current financial system is the willingness and ability of banks and other financial intermediaries to lend and leverage. The amount of money in the system ebbs and flows with that notion.
The willingness and ability to lend for the most part is a basic result of the return on money being greater than the cost of money to the lender. While the yield curve provides much of the information needed to determine the spread between the cost of money and the return on money, it is lacking. The component missing is inflation. Inflation is a cost of money for a financial lending institution as well. Inflationary expectations alter the landscape for lenders. The cost of money may be low today but may rise next year making the spread or profit on a marginal loan undesirable.
The best example of the predictive powers of this additional input is 1987. In looking at FIGURE 1 using a traditional yield curve, the cost of money never rises above the return of money in the fall of 1987. Looking at FIGURE 2 the adjusted cost of money rises above the return of money creating a liquidity crisis, resulting in a market crash.
The adjusted cost of money used in FIGURE 2 is 3 month TBill rates plus Currency Inflation.
Currency inflation is different than Consumer Price or Wholesale Price input which a). are lagging information and b). are not pure in that it can reflect shortages of goods. Currency inflation is determined by the present price of gold ( which we spoke about earlier as a store of value ). Gold provides an anchor to measure the dollars weakness or strength. Gold moves counter to the dollar. When confidence in the dollar wanes the dollar goes down, but we see at as rising gold prices. It is not the price of gold that is going up it is the fact that we are paying more dollars for this same store of value. While gold my not be the perfect proxy for the dollar
( actually an inverse proxy since they move opposite of each other ), it is believed by many to be the most accurate. So the Currency Inflation number is derived by taking the price of gold, inverting it and using a tabled formula creating a pure inflation number that is important in determining the cost of money.

Another important feature of the Liquidity Model is that it not only determines increase in liquidity ( meaning economic expansion ahead ) or lack of liquidity ( meaning economic slowdown coming ), it contains the type of contraction that is ahead.
Over the last 20 plus years we have had 3 deflationary financial contraction and 3 inflationary financial contractions. The deflationary contractions are also called recessions.

Note 1 . The charts could not be copied over, sorry.
Note 2 . In 2008 Gold and the US$ moved in the same direction. Kind of. Actually the US$ moved up against Other currencies. Gold prices moving up reflected that the US$ was simply the one eyed kind in the land of the blind. i.e. relatively the US$ was weak creating a cost of money number that created a virtually inverted yield curve. This explains why the yield curve is wide open yet there has been no GDP growth improvement and there will be no improvement until this is rectified.