Risk Premia Revisited
Recently we discussed how the Federal Reserve’s repeated hikes to short-term interest rates were finally having an effect on long-term government rates, but that corporate rates were hardly moving. Since corporations pay the corporate rate they were hardly affected by the series of rate hikes, which explained the continued market strength in the face of rising rates. Now corporate rates, too, may be rising. If so, they could have a long way to go.
The chart below details the difference (spread) between the typical corporate bond and the long-term US Treasury bond. Extremes in this relationship coincided with the market peak in 2000 and the subsequent trough in early 2003. Since then the spread has drifted back to the relatively low risk premium associated with the market peak (though much longer-term charts show that in the 1960’s the spread actually fell below one percent.)
With the market turmoil over the past week or so, the spread has widened (not surprisingly.) However, on the chart this widening is nothing more than a squiggle, from 1.6 percent to 1.65 percent. Given the sharpness of the market’s move on that 5-basis point widening, the long-term average of 1.8 percent seems far away indeed.
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