What Junk Bond Spreads Tell Us: Economy OK for Now

A wide gap between high-yield and 10-year Treasury signals a pending recession, says Natixis’ Lavorgna.

What are junk bond yields—specifically the spread between them and 10-year Treasury yields—telling us about the nation’s economic outlook? According to Joseph Lavorgna, chief economist, Americas, for Natixis, it’s bright, for now.

Despite handwringing over a trade war and other clouds on the horizon, the high-yield spread is not sending out a distress signal. Since the late 1980s, when the junk market had developed in earnest (thanks to Michael Milken and that era’s leveraged buyout craze), the junk-Treasury spread has peaked right before the recession hit.

That makes sense: As junk is perhaps the most vulnerable bond class, it stands to reason that investors would dump these issues, pushing down their price and elevating their yield.

But the spread nowadays is a benign 2.26 percentage points, Lavorgna noted in a research paper. That’s almost half of the 4.34-point average of the peak spreads that augured in the recessions from Milken’s time to the 2008-09 cruncher. 

Spreads reached their zenith in December 1989, at 4.43 points, seven months before the economy peaked and the 1990 recession started. Next, they topped out at 4.68 points in December 2000, three months before the economy hit its ceiling. On the eve of the Great Recession, spreads crested at 3.9 points, a mere one month prior to the economy’s high-water mark.

“Clearly, the lead time has been shrinking,” Lavorgna pointed out.  In other words, when the spread widens, we won’t have much time to brace for the downturn.

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