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Credit spread update: room for more improvement

The top chart shows credit default swap spreads for short-term corporate debt, while the bottom chart shows option-adjusted spreads for the whole corporate debt market. Both show that spreads have declined significantly since the worst days of the 2008-9 recession, but they also show that spreads are still substantially higher than they have been during times of relative economic tranquility.

I've argued repeatedly that the current level of credit spreads is a good indicator that the U.S. financial market is not overly exuberant, over-priced, or in another bubble. The market is still priced quite conservatively, and this is not surprising since there are still many problems facing the U.S. economy that must still be resolved (e.g., the huge unfunded liabilities of social security and medicare; the very large federal deficit; the unprecedented expansion of the size of the federal government; the still-large inventories of foreclosed homes, and the millions of homeowners who are "underwater" on the mortgages). We are moving in the right direction, but there is still plenty of room for improvement.

By inference, corporate debt still offers attractive spreads over Treasuries, especially in the high-yield sector.

Full disclosure: I am long HYG at the time of this writing.

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