Credit spreads

Recent movements in credit spreads (here the difference between yields on Baa and Aaa corporate bonds) tied to the Greek crisis are cause for concern:

But so far it's nothing like we saw two years ago:

The Baa-Aaa spread is important because it captures financial market participants' attitude toward risk. An increase in the spread means investors are shying away from risky securities and hoarding safe securities instead. This means that corporations face higher borrowing costs, which could reduce investment spending. It also reflects a general worsening of the psychological climate, which could mean lower spending across the board.

This is what people mean when they talk about the "headwinds" facing the economy as a result of financial stress. As I said in an earlier post, we're in a race between the forces of expansion and financial stress. Real economic expansion relieves financial stress - e.g. although Greece might still be having trouble servicing its debt if the world economy was not in recession, the other PIIGS (Portugal, Italy, Ireland, Spain) would be doing just fine. But financial stress retards economic expansion for the reasons given above. My money is still on the forces of expansion, but the increase in credit spreads has the potential to turn into something serious.