The Ominous Warning from Corporate Bond Spreads

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The current environment may be more uncertain and riskier than any we have seen in our lifetimes. Yet, corporate bond spreads say the future has never been more certain.

I recently wrote that line in The Markets Are Sending Confounding Messages. The article discusses a “metaphorical fog,” induced by central banks. The fog envelops all market signals and, in the process, takes away all means of orientation. Investors, unaware of the fog, investing aggressively with little concern.

This article examines the corporate bond fog. Corporate yields are priced for perfection while the economy languishes in what some describe as depression.

Quantifying warped perceptions

There are many ways to quantify risk. For this article, I use the economic policy uncertainty index (EPUI).

The EPUI is comprehensive, as it uses three distinct underlying components to measure the degree of economic uncertainty. Per the organization, its methodology is as follows:

To measure policy-related economic uncertainty, we construct an index from three types of underlying components. One component quantifies newspaper coverage of policy-related economic uncertainty. A second component reflects the number of federal tax code provisions set to expire in future years. The third component uses disagreement among economic forecasters as a proxy for uncertainty.

A high index level denotes more uncertainty, and conversely, a lower level reflects more confidence.

The index and its history can be found and downloaded on the St. Louis Federal Reserve’s web site.