In a recent research note Moody’s credit analysts note the action in the high yield bond market being consistent with leading recession indications:

“the widening by the high yield bond spread from an April 2011 average of 442 bp to a recent 732 bp warns of a possible quick end to the current credit cycle upturn. Each previous widening by the high yield bond spread to a width in excess of 700 bp occurred in the context of a credit cycle downturn that included a harsh and extended slump by high yield debt issuance. The record also shows that recessions tend to occur whenever the high yield bond spread’s month-long average tops 700 bp. The only exception to this tendency was the second half of 2002, or when a recession failed to materialize notwithstanding the high yield bond spread’s 784 bp average of that span.”

Now, I’ve been fairly clear that I think the “double dip recession” argument misses the point, but I think the message from high yield confirms other fears – credit markets are becoming increasingly fragile and are consistent with other very weak periods of economic growth.  As Moody’s notes, these events tend to be protracted events.  This is all consistent with the balance sheet recession theory.

Source: Moodys


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Sherman McCoy

    Your point of view may have some validity, but you also must bear in mind that at extremes, junk trades based on yield not spread. Essentially, Junk is a buy when yields discounted for default exceed equities, which they clearly did in 2008, and junk is a sell below 7% – which just happens to be the LT return for equities.

    The widening in the junk spread is largely a function of the drop in Treasury yields, not a change in credit perceptions. Think of Junk as equity with a coupon, since in the extreme that’s what it is, not as alternative to Treasuries.

  • http://www.pragcap.com Cullen Roche

    The change in Tsys is a function of credit perceptions….

  • SC

    Well I would say it is behavioural first and foremost.That is it is a change in willingess to accept risk of default within the wider economic enviroment taht people are looking at. Now that might be onebased on economic data ,or it could even be simple fear as of right now in the Euro markets inparticular which are feeding throughout every market because of the inter relationships.
    What we shoudl consider is what this means for funding costs and whether it will be impactful on businesses getting funding. With the latter I think this is not 2008 because many businesses ajudged by the record issuance have already been to the market.The BIG caveat for that is the banking sector iF they need to recapitalise via bond issuance it’s going to hurt a lot.
    We also need to consider under those circumstances what it means for the expansion of crdit to the property and consumer markets from that sector.

  • http://riskandreturn.net Lance Paddock

    “The change in Tsys is a function of credit perceptions….”


  • Mark

    No problem, monetize the long end. Problem solved, let the CONfidence games resume

  • Willy2

    There’re some good indicators available to see what’s happening with credit spreads and therefore I don’t need Moody’s or any other (discredited) rating agancy. (e.g. on http://Stockcharts.com). I watch; SLV/GLD, $UST/CYE, TLT/JNK, $LIBOR, $TED. And most/all ratios have shown more financial stress in the system in the last weeks.

  • Big Mac

    Cullen – Another excellent example of credit markets as a leading indicator. Do you know how far the series goes back and whether the data is publicly available? Thanks for keeping good info flowing.

  • marko

    “high yield bond spread to a width in excess of 700 bp”…

    looking at the chart “in excess of 550″ would be more accurate

  • KB


    On unrelated topic – did you have a chance to read Michael Pettis piece in businessinsider.com “The US is not about to turn into Japan”. It would be interesting to know your opinion on it.

  • http://www.pragcap.com Cullen Roche

    He seems to be making a point that I often make here – Japan suffered from an investment boom and we suffered from a consumption boom. So, in terms of the balance sheet recession, Japan had a corporate debt problem and the USA has a consumer debt problem. But he’s not viewing it from the perspective of a b/s recession so I think he’s missing the crucial point that ultimately makes the USA and Japan very similar. In the end, it’s a tautology to say that the USA is not becoming Japan just because we have a different sort of dynamic. Of course, they’re not the exact same, but they’re both debt bubbles of rare magnitude that cause the same economic phenomenon of deleveraging and sub-par growth.

  • http://www.globefuse.com Sebastian

    Can someone please explain, “widening in the junk spread is largely a function of the drop in Treasury yields, not a change in credit perceptions.”

    I would expect investors to look for yield seeing that treasuries aren’t providing income sufficient to deal with inflation. Yet, I guess such volatile and uncertain times negates such reasoning?

  • Dismayed

    My fear is that Michael Pettis is right and that we will not turn into Japan. We may, instead, end up turning in to the US circa 1938.

  • PrimeWolf

    So, is this a good time to buy more junk. Unless we are in the doomsday scenario, it seems so to me. Please enlighten me on the risks that the market seems to be punctuating.