When Treasuries are taken to zero, corporates look good

What would you rather hold? A 5-year Treasury which is priced at a break-even inflation rate of under 20 bps versus TIPS or a corporate bond that may be propped up by the government. This should be a no brainer trade especially given the wide spreads which place us at the worst corporate debt risk since the Depression. Trade inflation risk for credit risk when we are seeing further deterioration in the economy would seem like a silly thing to do except if the spread is hefty enough and the absolute level of Treasuries is low enough. We may have those conditions. While there will be significant defaults and low recoveries, there is the flip side that the government has a large stimulus package to take effect in the Spring and there has been aggression action in the the money market to providing liquidity for commercial paper. Now we are seeing the Fed of New York actually buying mortgage paper.

Corporate spreads usually do not tighten until the employment level has peaked but the spread widening in corporate has been associated with a liquidity crunch which has extended beyond the probability of default and recovery. There is also a liquidity risk which was not present before in these markets, so investors are getting paid for more than just default risk.

While nothing a no-brainer, there have been periods when fixed incom outperforms stocks and the corporate bond market especially for investment grade may be a better bet than the equity alternative.