High-Yield Spreads and How They Work

A yield spread is defined as the difference between yields on debt instruments of various maturities, credit ratings, or risk levels. They are typically calculated by subtracting the yield of one instrument from the other and presenting that difference in percentage points. On the other hand, a high-yield bond spread, also referred to as the credit spread, is the percentage difference in current yields of various classes of high-yield bonds compared against investment-grade corporate bonds or Treasury bonds. What happens is that these types of bonds offer high interest rates because of their high risk of default. The main characteristics that draw investors to these high-risk investment options are the high-interest rates. The greater the risk of default risk, the higher the interest rates.

Overheating Economy and Bonds

An overheating economy is one that’s experiencing an extended period of positive economic growth which often leads to high levels of inflation. Unfortunately, these periods eventually hinder the economy’s growth and often lead to a recession due to their unsustainability. So, what does it mean for bond investors maneuvering the overheated economy? First, rising inflation is never good news for bonds because it erodes their value, which is why most investors prefer stocks in such environments. However, investor concerns about the current bond environment are misplaced because the bond markets are at their most attractive in a long time. Inflation worries have led to a sharp rise in bond yields in recent weeks due to the accompanying fall in bond prices; prices move inversely to yields.

Links and Resources

Dan Rasmussen and Igor Vasilachi, The Best Macro Indicator, May 17, 2021: https://verdadcap.com/archive/the-best-macro-indicator

ICE BofA US High Yield Index Option-Adjusted Spread (BAMLH0A0HYM2): https://fred.stlouisfed.org/series/BAMLH0A0HYM2

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