Credit spreads

One would imagine that as a consequence of all the geopolitical events occurring these days, markets should be concern, volatile and to a certain extent scared. But as we await what could be the largest real estate transaction in recent history, markets continue to be at or near all thin highs. In the case of the credit markets, as you can see in the chart below, credit spreads are at the lowest point they have been since 2007, prior to th GFC. Credit spreads measure how risky bonds issued by corporations are comprared to the governemt curve. High spreads mean corporations are relatively risky. Low spreads means they’re relatively safe. A zero spread would mean that an investor would be indifferent between a government bond and a corporate bond, since they would have the same yield for the same or similar maturity. Since government bonds have historically been perceived as the risk free rate, they were considered the reference point. Bit perhaps the historically narrow spreads may be telling us that the basis (government bonds) is not risk free. Due to the amount of debt outstanding issued by countries that have tapped the bond markets to pump their economic growth, investors may prefer a corporate risk, if the issuer has a clean balance sheet. Would you rather lend money to Microsoft or the U.S. Treasury? You should choose the U.S. treasury because they have the ability to tax and the Fed can print money. But that argument is getting weaker by the minute, epitomized by gold and silver incredible run up, as the dollar is being debased. 2007 was the year prior to one of the worst financial crisis in history. Absent the intervention by the Fed and the U.S. government, it could have been a depression. We’re at similar levels today. At the time, corporations, particularly banks were levered to their eyeballs, and the government debt was low. One of the biggest transfers of debt (from corporations to the government) in human history happened between 2007-2010. The question is: Who would bail out who in today’s market?

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