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Yield Spread

Definition

In finance, the yield spread or credit spread is the difference between the quoted rates of return on two different investments, usually of different credit qualities but similar maturities. It is often an indication of the risk premium for one investment product over another. The phrase is a compound of yield and spread.

Yield Spread

What is a 'Yield Spread'

A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings and risk, calculated by deducting the yield of one instrument from another. For example, if the five-year Treasury bond is at 5% and the 30-year Treasury bond is at 6%, the yield spread between the two debt instruments is 1%. If the 30-year bond is trading at 6%, then based on the historical yield spread, the five-year should be trading at around 1%, making it very attractive at its current yield of 5%.

Explaining 'Yield Spread'

The yield spread is a key metric that bond investors use when gauging the level of expense for a bond or group of bonds. For example, if one bond is yielding 7% and another is yielding 4%, the spread is three percentage points, or 300 basis points (BP). Non-Treasury bonds are generally evaluated based on the difference between their yield and the yield on a Treasury bond of comparable maturity.

Yield Spread and Risk

Typically, the higher risk a bond or asset class carries, the higher its yield spread. When an investment is viewed as low-risk, investors do not require a large yield for tying up their cash. However, if an investment is viewed as higher risk, investors demand adequate compensation through a higher yield spread in exchange for taking on the risk of their principal declining. For example, a bond issued by a large, financially healthy company typically trades at a relatively low spread in relation to U.S. Treasuries. In contrast, a bond issued by a smaller company with weaker financial strength typically trades at a higher spread relative to Treasuries. For this reason, bonds in emerging markets and developed markets, as well as similar securities with different maturities, typically trade at significantly different yields.

Yield Spread Movements

Because bond yields are often changing, yield spreads are as well. The direction of the spread may increase or widen, meaning the yield difference between two bonds is increasing, and one sector is performing better than another. When spreads narrow, the yield difference is decreasing, and one sector is performing more poorly than another. For example, the yield on a high-yield bond index moves from 7% to 7.5%. At the same time, the yield on the 10-year Treasury remains at 2%. The spread moved from 5 BP to 5.5 BP, indicating that high-yield bonds underperformed Treasuries during that time period.


Yield Spread FAQ

What is the current yield spread?

Yield Spread is at 0.81%, compared to 0.76% the previous market day and 0.22% last year. This is lower than the long term average of 0.93%.

What does yield spread mean?

A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings, issuer, or risk level, and calculate it by deducting one instrument's yield from the other. This difference is most often expressed in basis points (bps) or percentage points.

Why do yield spreads widen?

Credit spreads widen when U.S. Treasury markets are favored over corporate bonds, typically in times of uncertainty or when it's expected that economic conditions will deteriorate.

How many times has an inverted yield curve predicted a recession?

The inverted yield curve has consistently predicted a recession each of the 5 times in the last 5 decades.

What does it mean when the yield curve is flat?

A flat yield curve means that people are willing to get the same interest rate to loan their money short-term as they would if they loaned their money long-term. An inverted yield curve means people will accept a lower interest rate for loaning money for a longer term.

How do you find the yield curve?

Access the Yield Curve page by clicking the “U.S. Treasury Yield Curve” item under the “Market” tab.

Further Reading

A re-examination of the predictability of economic activity using the yield spreadA re-examination of the predictability of economic activity using the yield spread
www.nber.org [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

The high-yield spread as a predictor of real economic activity: evidence of a financial accelerator for the United StatesThe high-yield spread as a predictor of real economic activity: evidence of a financial accelerator for the United States
link.springer.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

The information in the high-yield bond spread for the business cycle: evidence and some implicationsThe information in the high-yield bond spread for the business cycle: evidence and some implications
academic.oup.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

Re-examination of the predictability of economic activity using the yield spread: a nonlinear approachRe-examination of the predictability of economic activity using the yield spread: a nonlinear approach
www.sciencedirect.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

The yield curve and real activityThe yield curve and real activity
link.springer.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

Does the Yield Spread Predict Recessions in the Euro Area?Does the Yield Spread Predict Recessions in the Euro Area?
onlinelibrary.wiley.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

Determinants of market-assessed sovereign risk: Economic fundamentals or market risk appetite?Determinants of market-assessed sovereign risk: Economic fundamentals or market risk appetite?
www.sciencedirect.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …

Predicting real growth and the probability of recession in the Euro area using the yield spreadPredicting real growth and the probability of recession in the Euro area using the yield spread
www.sciencedirect.com [PDF]
… Since then, various authors have investigated a variety of alternative interest rates and spreads.1 … yields according to the expectations hypothesis. Both of these interpretations of the yield spread's usefulness for forecasting real output …


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