Usually an economic downturn is associated in a big increase in the spread between corporate and Treasury yields. This spiked pretty dramatically last week, but still has a long way to go.
The above graph plots monthly averages of the corporate-Treasury yield spread through July. Going back to 1953, this spread averaged 170 basis points,
and typically rose over a hundred basis points during an economic downturn. Insofar as there is a higher probability of default during an economic recession, even risk-neutral investors would require a higher yield on corporate debt when more businesses are failing.
This spread spiked substantially last week, as long-term Treasuries fell 20 basis points while the Baa yield showed little movement. Even so, the current spread of 206 basis points is not much above the long-term average or the short-term range we’ve seen over the last two years.
If the financial turmoil over the last few weeks reflects fears of a significant economic downturn and financial distress, I would have expected to see an even bigger spread at this point.