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Posts tagged with: "AAA"

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Risky business?

How much economic risk are businesses facing these days? FRED can help us consider what the market is telling us about the level of risk by showing us the yields of various types of corporate bonds. Moody’s business is, in part, to classify corporate bonds according to their risk, and bonds within a rating should have the same level of risk through time. The yields of these bonds may still change, though, because they’re driven mostly by a risk premium (which is different in each risk rating) and the supply and demand of funds. An easy way to properly measure the latter is to take the difference between the yields of two risk ratings. In the graph, we’ve done this for the ratings Aaa and Baa. What remains is the excess risk of Baa over Aaa bonds. Indeed, as the economy becomes riskier, lower-rated bonds will become riskier more quickly than higher-rated bonds. The graph shows that risk today (at the date of this writing) is basically historically normal, if a little elevated compared with previous years. However, it’s nowhere near as risky as it was during the Great Depression, the early 1980s, or the Great Recession.

How this graph was created: Search for and select “Moody’s Baa” and click “Add to Graph.” From the “Edit Graph” panel, add a series by searching for “Moody’s Aaa” and apply formula a-b.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: AAA, BAA

Getting back to normal? Part 2

Are real interest rates trending down to "normal"?

In our previous post, we mentioned that the Federal Open Market Committee (FOMC) is trying to normalize interest rates by gradually increasing the target for the federal funds rate. But what is the “normal” interest rate? Some people are arguing that it’s actually lower than what it has been before. One way to try to identify this normal state is by looking at long-term trends in interest rates: Presumably, long-term forces are what move the normal level of interest rates. (In contrast, interest rates respond in the short term to economic fluctuations rather than trends.) So we’ve graphed three popular interest rates that have a longer time series: the 1-year Treasury bond rate, Moody’s Aaa corporate bond rate, and the federal funds rate.

Can you see a trend? Of course, you can. There’s a trend increase until the end of the 1970s and then a trend decrease. And, of course, this has to do with the history of inflation. This is why people tend to discuss trends in real interest rates without the inflation component. But it’s not perfectly clear how to determine that inflation component: Indeed, interest rates are driven by markets and what they think inflation will be over the life of the bond or the period of credit. The data we have cover past inflation. While past and future inflation may be correlated, they’re not the same thing. Over the longer run, however, using realized inflation as a proxy for expected inflation works reasonably well, with exceptions. So we move to the second graph, where we’ve taken the same three interest rates and subtracted the CPI inflation rate from each. Do we see a downward trend? It looks like there’s one from 1980 to the Great Recession. After that, it’s subject to debate.

How these graphs were created: For the first graph, search for “1- year treasury rate” and take the monthly, constant maturity series. Then from the “Edit Graph” section, use the “Add Line” option and search for and add “aaa” and then also “fed funds rate,” each time taking the monthly rate. Finally, start the graph in 1955. For the second graph, repeat this process for each line: search for and add “CPI,” modify its units to “Percent Change from Year Ago,” and apply formula a-b.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: AAA, CPIAUCSL, FEDFUNDS, GS1

Measuring risk

How much risk is in the economy? It depends what you mean by risk. If you want to know, roughly, the level of risk that businesses cannot honor their debts, then you want to look at the risk premium. The risk premium quantifies the differences in the yields of bonds in different risk categories. This risk premium is not constant through time: It changes as the overall economy goes through its ups and downs that impact businesses. Here we look at the difference in yields between Moody’s Aaa and Baa corporate bonds. It is clearly visible that much risk was present in the 1920s, 1930s, and 1940s and also in several of the recent recessions, in particular the previous one. Lately, this risk has largely been vanishing, as corroborated by the St Louis Fed Financial Stress Index©.

How this graph was created: Search for “Moody’s” and select the Aaa rate at a monthly frequency (for a longer sample). Then you add the Baa series and apply transformation “b-a.”

Suggested by Christian Zimmermann

View on FRED, series used in this post: AAA, BAA

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