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Posts tagged with: "BAA"

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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

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

Dating the financial crisis using fixed income market yield spreads

How would you answer the question, “When did the Great Financial Crisis begin?” Some date the beginning of the crisis according to the events surrounding the failure of Lehman Brothers in mid-September 2008. But at that point, financial markets had already been in turmoil for more than a year, as certain time series from the summer of 2007 show. So how do you date the crisis?

One way to date the recent financial crisis is to identify significant breaks in the dynamics of yield spreads from U.S. fixed income markets (thought to be at the core of the crisis) using appropriate statistical techniques, like I do in a forthcoming article (working paper version) along with coauthors Massimo Guidolin and Pierangelo De Pace. With a particular definition of financial crisis in mind, this procedure allows us to identify the weeks of August 3, 2007, and June 26, 2009, as the beginning and the end of the crisis, at least from the perspective of fixed income yield spreads.

While some of the spreads we use are based on proprietary data, several can be constructed from FRED data. In the graph, we plot the spread between Moody’s seasoned Aaa corporate bond yield and Moody’s seasoned Baa corporate bond yield, as well as the spread between the 30-year fixed-rate mortgage average in the United States and the 30-year Treasury constant maturity rate.

Even just eyeballing the graph gives a sense of the degree of comovement of these spreads at least for the period beginning in 2007. Moreover, the spreads show an upward shift in their level approximately in the second half of 2007 as well as a downward shift approximately in mid-2009.

How this graph was created: In FRED, enter “Moody’s” in the search box. This will return a few Moody’s series: I first selected the Baa corporate bond yield and then added the Aaa corporate bond yield. The spread is then the difference between the two: a-b. A similar transformation was applied to the 30-year Treasury constant maturity rate and the 30-year fixed-rate mortgage average in the United States.

Suggested by Silvio Contessi

View on FRED, series used in this post: AAA, BAA, DGS30, MORTGAGE30US

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