Long Term Perspective

The 10-year Treasury note, rather than the 30-year bond, has become the benchmark security from which corporate interest rate levels are derived.  All corporate bond yields in the charts below are rated by Citigroup Global Markets. Triple A rated bonds have the lowest risk of default, whereas Triple B bonds have the highest default risk among this group. Triple B bonds can be considered junk bonds, although distressed bonds are also rated “C” by some rating agencies.

Investors would choose the amount of risk that they could tolerate. Those with low risk tolerance would choose the Treasury security for the lowest default risk, while investors with high risk tolerance might prefer the Triple B instrument with the highest default risk. A lower default risk comes with a lower yield; conversely, the higher the default risk, the higher the yield.

The spread between Treasury securities and corporate bond yields are not uniform over the business cycle. Spreads widen during recessions when default risk is higher for all corporate bonds. Spreads narrow during boom times because default risk for all bonds diminishes when the economy is healthy.

Short Term Perspective

Typically, Treasury securities have the lowest risk – and therefore the lowest yields. This was not always true between 2002 and 2005, although the 10-year Treasury note has had a lower yield since the second half of 2005. It is possible that some of the securities had shorter maturities, which would have generated lower yields than those securities with longer maturities. The spread between average AAA/AA corporate bond yields and the 10-year note increased to +52 basis points in 2006 from +24 basis points in 2005 as the Fed continued to tighten and remained as markets eased late in 2006. More recently, the spread stood at 82 basis points in November 2007 as the 10-year Treasury has fallen more than the corporate bond, partly reflecting flight to quality.

The spread between average A corporate bond yields and the 10-year note increased to 86 basis points in 2006 from 65 basis points in 2005. The spread stood at 132 basis points in November 2007. Finally, the spread between average BBB corporate bond yields and the 10-year Treasury note edged down to 125 basis points in 2006 from 131 basis points in 2005. This spread stood at 186 basis points in November 2007.

Average yields were down in November. The 10-year Treasury note yield declined 38 basis points to 4.15 percent while these corporate bond yields fell 15 to 24 basis points.