Spreads widen or narrow prior to recession?

[daveyc18]

CFAI curriculum
-fixed-income book, page 21…”4. sector and quality position….”spreads are expected to widen (e.g., prior to recession)…”
-capital market expectations/economic analysis, page 57, example 22: “…spread to narrow or become negative prior to recessions.”)
Am I missing something here?
Thanks for the replies!

 

[cpk123]

aren’t they talking about 2 different yield spreads?
Capital Market - yield curve is the trasury yield curve - between 10 Yr and 3 Month treasury securities. Prior to a recession - I think the 10-Yr treasury would tend to be reduced (maybe due to external actions) and so would the 3-Month Treasury yield, and since both are reduced - this spread would narrow.
Fixed Income book 1 -> they are taking about SECTOR spread - spread between securities in a particular sector and the Treasury security. Treasury Security yield reduced - so this spread would widen - assuming nothing happened to the yield in the sector. Even if it reduced - this reduction should be lower than the treasury yield - so overall this yield would widen.

 

[daveyc18]

thx

 

[janakisri]

If recession is imminent monetary policy would tend to be relaxed by the central bank . Rates at the short end of the treasury yield curve would be reduced ( to accomodate stimulation of the economy ) . Investors would flee to the longer end of the curve , to chase better yields , and the rates would fall ( prices would rise) at the longer end too, as supply wpuld be strained by the demand. So overall , the yield curve would begin to flatten or the spreads ( e.g. 10 ‘s to 2’s ) would narrow.
At the corporate sector , it would be a different story . As risk is perceived to increase for corporates due to recessionary trends , spreads at all but the most resilient industries ( non-cyclicals ) would begin to widen . Flight to safety would ensue .

 

[FinNinja]

Good point Janakisri - Flight to safety makes a compelling argument!