Every once in a while, the term “bond spread” pops up in financial reporting. Most people (who aren’t money nerds) don’t know what this means and how big a deal it sometimes is. So — since it’s a major red flag at the moment — this might be a good time to discuss it:
Bond spreads refer to how different kinds of bonds in a given category can have different yields. The gap between one kind of bond and another is the “spread.”
Sometimes, the gap between relatively safe bonds and more risky bonds conveys important information. When this spread is wide, it means bond buyers are nervous about the future and are demanding higher interest rates to induce them to buy risky bonds.
When the opposite is true — narrow spreads between safe and less safe bonds — that tells us that bond buyers are confident about the future and are willing to buy risky bonds even if they yield only a little more than safe ones.
At the extremes, bond buyers, like the rest of us, tend to be guided by emotion and are therefore frequently wrong. So small spreads mean bond buyers are possibly overconfident, while wide spreads denote the opposite.
Where is today’s corporate bond market? At scary levels of complacency
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