Bond spreads are an important indicator of risk in financial markets. When corporate bond yields are at a substantial premium to Treasury yields, that indicates higher default risk among large corporations. The graph below, from the RBA chart pack, shows the premium charged for AA-rated corporations compared to US Treasuries. Anything over 150 basis points (bps) indicates elevated risk. For lower-rated BBB corporations, a spread greater than 300 bps is cause for concern. At present, both credit spreads are trending lower, suggesting that financial risk is easing.
Australia displays a similar picture, with AA-rated spreads trending lower. BBB spreads are also falling but remain high at 200 bps relative to 150 bps in the US, reflecting Australia’s vulnerability to commodities and real estate (both here and in China).