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Credit-Market Sentiment and the Business Cycle
Report

Credit-Market Sentiment and the Business Cycle


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Editorial Rating

7

Qualities

  • Analytical
  • Innovative
  • Visionary

Recommendation

Stock markets might be notoriously unreliable predictors of economic activity, but credit markets seem quite accurate at forecasting the future. Economists David Lopez-Salido, Jeremy C. Stein and Egon Zakrajsek analyzed decades of American market data and found that if spreads are low and junk bonds are popular today, you can expect a downturn in two years. Exactly why this occurs is open to debate, the authors admit, but it’s a tidbit of intelligence that savvy investors might want to take under advisement. One caveat: With a few exceptions, this report’s turgid prose will be tough sledding for readers who don’t possess advanced training in economics. Nonetheless, getAbstract recommends it to investors and policy makers for its insight into credit markets and the economy.

Take-Aways

  • A study of America’s financial markets between 1929 and 2013 shows that periods of optimistic lending climates led to worsening conditions two years hence.
  • Credit market sentiment is buoyant when bond spreads are narrow and high-yield bonds are plentiful.
  • While credit market sentiment provides accurate predictions, stock market sentiment offers no such premonitions.

About the Authors

David Lopez-Salido and Egon Zakrajsek are economists at the Federal Reserve. Jeremy C. Stein is an economics professor at Harvard University.


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