High-yield spreads heading south

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The spread on junk bonds has been declining consistently over the past few months and has now reached the lowest level since September last year. High-yield spreads, as shown by the Merrill Lynch US High Yield Index, have dropped by 51.5% to 1,059 from a record high of 2,182 on December 15. This means the spread between high-yield debt and comparable US Treasuries was 1,059 basis points by the close of business on Friday. This level is still 155 basis points above the pre-Lehman bankruptcy levels.

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Source: Merrill Lynch Global Index System

Another indicator worth monitoring is the Barron’s Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. There has been a solid improvement in the ratio since its all-time low in December, showing that bond investors are growing more confident and have started opting for more speculative bonds over high-grade bonds. Again, the Index is back at September levels.

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With the US 10-year Treasury Note yield at 3.88%, high-yield borrowers still have to pay 14.47% per year to borrow money for a 10-year period. At these rates it remains almost impossible for companies with a less-than-perfect credit status to conduct business profitably.

Although high-yield spreads have narrowed considerably and the credit convalescence process seems to be on track, they still has a way to go before reaching pre-crisis levels and investor confidence returning to more “normal” levels.

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