Recent corporate spread tightening following the Fed funds rate cut is being touted by some market players as indicative of a mature market where investors are able to anticipate events months before they happen. In the mid-1990s the lag effect between the positively correlated Fed funds rate and corporate spreads could be as much as two years. But market reaction to the Fed's recent 50 basis points of easing immediately tightened spreads 20-40 basis points, says John Kollar, corporate strategist at HSBC Securities in New York. "[This is a] structural change associated with a more mature corporate bond market," he adds. Milton Ezrati, strategist and economist at Lord, Abbett & Co. in New York, agrees the corporate market has matured, but unlike Kollar, he considers the speed with which spreads narrowed just a sigh of relief from a market heavily apprehensive of a slowing economy and a looming recession. "The market was in the midst of a near panic when the Fed eased," says Ezrati.
Another reason for the quick corporate spread narrowing is the widening of Treasury spreads. "The Treasury market backed up a bit, and while the corporate market took the Fed's move as an unmitigated positive, the Treasury market was worried about inflationary pressures," says Ezrati. Thirty-year long bonds are yielding 10 basis points more than their lows in the fourth quarter of last year, "so if long corporate bond yields are narrowing by 20-30 basis points, about one-third of this is because Treasury yields have widened." Ezrati predicts that high yield spreads will shrink to half by year-end, and that investment-grade corporates spreads will also shrink extensively in the next three to six months.
