Corporate bond spreads continue to tighten (Aug 09)

The spread of A-rated, 7-10 year UK corporate bonds over gilts over an equivalent maturity has plummeted to around 4% from more than 10% in the dark days of spring. Admittedly, corporate bonds spreads in the UK remain wider than in the US and euro-zone. But the scope for further narrowing is limited unless we are heading for a re-run of the credit bubble. That seems unlikely. The extension of quantitative easing in August may lead to further flows into risky assets in the near term, but there are grounds for caution. Not only has a lot of the risk aversion previously factored into market prices disappeared, but the economic recovery itself is likely to be unusually fragile.