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Tuesday, January 20, 2009

Spreads: Not Seen Since the Great Depression

JG provided an interesting insight in the comments section of my "Real Yields Matter" post. Credit risk premium, as defined by the difference between the yield of the Moody's Baa and Aaa rated indices (more detail regarding Moody's here), recently moved above 3%. What is the significance?

As of Nov. ‘08, the Baa-Aaa risk premium moved above 3.0%, to 3.07%; in December, it was 3.38%.
When were the last times that the Baa-Aaa risk premium rose above 3.0%? August ‘31, October ‘32, October ‘33, and March ‘38, in the depths of the Lesser Depression (first two) and its protracted recovery (last two).

We are one year into The Greater Depression.

In plotting the data, JG is correct. Although we were awfully close in the early 1980's and 338 bps is a a lot smaller than the 560+ bps we saw in 1932, this does put the current crisis into the correct context.

Source: St. Louis Fed (BBB) / St. Louis Fed (AAA)