Martin Fridson, chief high yield strategist at Merrill Lynch in New York, expects high-yield spreads to treasuries to narrow 25 basis points in the event of a 50 basis point cut in short-term rates, which is expected this week. The move reflects the thinking that a cut will drive investors into junk funds in search of yield, and that low rates make it cheaper for dealers to borrow money to take on inventory, thereby improving secondary market liquidity.
But, Fridson says Merrill's model indicates spreads are already trading 34 basis points wider than they should be. This is technically "fair value," allowing for Merrill's 50 basis point margin of error, but still a solid buying climate for high yield, he adds.