Saturday, September 12, 2009

What Bond Markets Are Telling Us

Above, we can see a five-year picture of Vanguard's intermediate-term investment grade municipal bonds (VWITX; top chart) and intermediate-term investment grade corporate bonds (VFICX; bottom chart).

Both plunged precipitously in the credit crisis immediately surrounding the Lehman failure. Both also made higher lows when stocks hit their bottom in March, 2009, suggesting that some measure of stabilization had already occurred.

The importance of such investment grade bonds is that their pricing reflects an estimate of likelihood of default, as well as outlooks for future interest rates.

What we've seen of late are continued highs in these bond markets. Investors are neither pricing in high odds of default, nor are they anticipating higher interest rates to come. This has been an important psychological backdrop to the stock market rally.