Long Term Perspective

Equity investors know that various sectors of the economy perform differently over the business cycle. Thus, stock prices will ebb and flow with or against economic activity. Similarly, bonds in various sectors of the economy will bear different risk levels, just like stocks, depending on the pace of economic activity. For instance, among this group (services and consumer), consumer sector bonds offered lower yields than the service sector since 2000, probably because these were viewed as having lower risks of default over the time horizon. The gap narrowed dramatically versus each other and relative to the 10-year note yield in 2003, likely reflecting a strengthening in quality (lower default risk) in services bonds relative to consumer sector bonds. However, both lost ground in terms of risk relative to the 10-year Treasury bond during 2006 as the Fed’s tightening during the first half of 2006 and continued tight stance in the first half of 2007 raised the default risk for the private sector bonds. Subprime worries and flight to safety as equities plummeted during the second half of 2007 and into late 2008 led Treasury rates to decline relative to services sector and consumer sector bonds.  But these corporate rates fell in 2009 and well into 2010 as the recovery gained traction, worries over the financial sector subsided, and inflation eased.  A strengthening recovery bumped yields up in early 2011 but slower growth at mid-year tugged down on rates into 2012.

Short Term Perspective

Spreads widened in 2007 and into 2008 over increased concern about recession depth.  The spread between service sector and consumer sector bonds and the 10-year Treasury note hit recent highs of 469 basis points and 390 basis points, respectively, in October 2008.  That reversed somewhat in 2009 and into mid-2010 as economic data were more positive, confirming recovery. By mid-2010, corporate rates were looking more attractive relative to Treasuries, helping ease yields.  By early 2011, signs of a healthier recovery, higher inflation, and a pending end of the Fed’s quantitative easing led rates up.  But at mid-2011 and into 2012, sluggish growth led to softer rates.

In October, the spread for the services corporate bond and the consumer corporate bond stood at 82 basis points and 43 basis points, respectively.

Corporate yields in October dipped 9 basis points for services and 8 basis points for consumer sector bonds, while the 10-year Treasury note yield gained 3 basis points.  This put rates for services and consumer sector bonds at 2.57 percent and 2.18 percent, respectively, with the 10-year T-note at 1.75 percent.