Bond Spreads Point to Normalizing Economy

But no wage gains and cautious consumer confidence.

April 8, 2010

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446743_50607743Bad news for investors might be good news for the economy – but no news for workers. The Dallas Fed reports that the spreads between junk bonds and Treasuries and between corporate bonds and Treasuries are now at levels last seen in mid-2008.

But the Dallas Fed isn’t overly optimistic in its latest National Economic Update, released March 31. Says David Luttrell, a Dallas Fed research assistant: “Recent data point to a mild firming of the underlying pace of final demand growth. However, questions remain as to the sustainability of growth as conventional monetary and fiscal policy stimulus efforts fade over the course of this year. Improving trends in production and employment suggest that job losses might soon give way to modest gains. In light of continued debt deleveraging and tight credit conditions, persistent economic slack will likely continue to constrain inflationary pressures and expectations.”

Still, the normalization of bond spreads is startling to view as the chart shows.

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Junk spreads soared to almost 21% and are now at about 5%; corporates went to 6% and are now around 2.5%. They’re approaching rates typical of a growing economy rather than a contracting one. So the capital gains turkey shoot is over; now it’s back to finding forgotten easter eggs.

Bond investors are clearly more confident about getting their money back, and corporations have access to money. The question, as always, is how will they use it – especially with far-from-ebullient consumer confidence, and record wage disinflation.

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