Differences between long- and short-term Treasury yields, known as the yield curve, and corporate bond and Treasury yields, known as credit spreads, have historically been important indicators of current market conditions. Flat yield curves (with long- and short-term Treasury yields roughly equal) and narrow credit spreads - indicating little expected inflation or rising interest rates and credit defaults, respectivlely - generally characterize seemingly low risk environments. Those were the conditions along with rising equities going into 2007, prior to the financial collapse, and are surprisingly similar today. Could this be the calm before the next storm?
While the current environment is very different from the earlier one, it is characterized by ever increasing leverage across the economy as a whole. Look for sharp increases in corporate spreads and possible inversion of the yield curve (i.e., long- below short-term Treasury yields) this time around, suggesting an oncoming recession, to signal new turmoil in equity markets.
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