Thursday, April 09, 2009

Using Corporate Bonds as an Economic Predictor

by Calculated Risk on 4/09/2009 07:55:00 PM

UPDATE: Here is the paper: Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets (ht MrM who writes: "Please note that the authors construct their own bond indices, so one should not draw conclusions about their paper by looking at Moody's charts")

Justin Lahart reports in the WSJ on a new research paper: Giving Corporate Credit Its Due (ht James)

In a forthcoming paper in the Journal of Monetary Economics [economists Simon Gilchrist and Vladimir Yankov at Boston University, and Egon Zakrajsek at the Federal Reserve] show that spreads on low- to medium-risk corporate bonds, particularly those with 15 or more years until maturity, predicted changes in the economy phenomenally well, forecasting the ups and downs in both hiring and production a year before they occurred. Since writing the paper, they extended their analysis back to 1973 and found bonds' predictive ability still held.

With the massive widening in corporate-bond spreads last fall, the economists' model predicts industrial production will fall another 17% by the end of the year, and the economy will lose another 7.8 million jobs on top of the 5.1 million it has shed since the recession began. Ouch.emphasis added
I haven't seen the paper yet, but here are the spreads I've been following based on 30 year corporate bonds.

Spread Corporate and Treasury Click on graph for larger image in new window.

This graph shows the spread between 30 year Moody's Aaa and Baa rated bonds and the 30 year treasury.

It looks like this spread has predicted a few extra recessions! I'm looking forward to the paper.