Interesting piece. Should spreads be thought of as an absolute pickup over risk free rates, or in percentage terms? Surely T+50bp is a lot more interesting when UST is 100bp versus when UST is 400bp.
Also can spreads ever be negative? Should a corporate ever have a yield lower than the risk free rates?
So, we know for a fact (observation) that G-spreads can trade negative - an EM trader friend told me yesterday that Abu Dhabi trades T-20. I haven't fact checked this but I believe him! We also know that corporate spreads have traded tight in periods, though only slightly tight and usually for short periods.
That leads me to a slightly different question: WHEN are spread negative?
That obvious answer is when the sovereign itself is in stress - many corporates (and even banks) traded through Italy for a prolonged period during the euro area sovereign crisis, because there was a real degradation of the sovereign credit. Credit can also trade through for short periods when there are technicals on either the corporate bond (e.g. call language, buybacks) OR when there is technical pressure on the government, e.g. mass selling of spanish covered bonds by German investors in 2011/12.
As for your first question, while that makes intuative sense (50bp of 100 is more than 50bp of 400!) historically that is not what we see. So while it looks good on paper, it doesn't align with what we have seen historically. In €-IG we had periods where spread was 200-300% of the yields (spread at 80bp, yields at 25bp), an nothing particularly magical (or terrible) happened.
Interesting piece. Should spreads be thought of as an absolute pickup over risk free rates, or in percentage terms? Surely T+50bp is a lot more interesting when UST is 100bp versus when UST is 400bp.
Also can spreads ever be negative? Should a corporate ever have a yield lower than the risk free rates?
Great questions and I have some thoughts.
So, we know for a fact (observation) that G-spreads can trade negative - an EM trader friend told me yesterday that Abu Dhabi trades T-20. I haven't fact checked this but I believe him! We also know that corporate spreads have traded tight in periods, though only slightly tight and usually for short periods.
That leads me to a slightly different question: WHEN are spread negative?
That obvious answer is when the sovereign itself is in stress - many corporates (and even banks) traded through Italy for a prolonged period during the euro area sovereign crisis, because there was a real degradation of the sovereign credit. Credit can also trade through for short periods when there are technicals on either the corporate bond (e.g. call language, buybacks) OR when there is technical pressure on the government, e.g. mass selling of spanish covered bonds by German investors in 2011/12.
As for your first question, while that makes intuative sense (50bp of 100 is more than 50bp of 400!) historically that is not what we see. So while it looks good on paper, it doesn't align with what we have seen historically. In €-IG we had periods where spread was 200-300% of the yields (spread at 80bp, yields at 25bp), an nothing particularly magical (or terrible) happened.