High-yield and corporate credit market analysts expect spreads to narrow significantly by early next year, if not sooner. John Lonski, chief economist at Moody's Investors Service, says high-yield spreads could contract by as much as 100 basis points by early 2002. Lonski notes that corporate borrowing costs are extremely low. Three-month LIBOR, he says, is at its lowest point since February 1994, and is down 3% from a year earlier--the steepest year-over-year decline since 1992. He also expects issuance to decline as companies become more cautious in their use of leverage. These factors, he says, point to a decline in the ratio of downgrades to upgrades, and a narrowing of yield spreads.
Martin Fridson, high-yield strategist at Merrill Lynch, says a decline in the downgrade:upgrade ratio points to a decline in the default rate, which in turn tends to precede a contraction in spreads six months later. Since the downgrade:upgrade ratio began to go down in the first quarter of this year, spreads should begin narrowing sooner than next year. He declines to name a precise target for how far they will contract, but says Lonski's figure is not unreasonable. Fridson notes that a decline in the default ratio is only one of several factors that Merrill considers when making its bi-annual official forecast. However, he says it is reasonable to assume that those other factors, such as mutual fund flows and the steepness of the Treasury yield curve, will not vary significantly from present conditions.