Easier lending standards signal lower default rates in future. Banks will usually ease their lending standards only when an upturn in the economy is in sight and companies have greater prospects for profits. During an economic slowdown the net percentage of banks tightening their standards will rise. This could be observed in 1990/91, and then during 1998 with the Asian crisis and LTCM. The last period of tight lending standards was seen between August 2000 and November 2001 when the US economy went through a recession. Since then, with improving macroeconomic data, banks started to ease their lending standards and companies’ demand for loans started to increase at the same time. Ahigh correlation of 0.79 exists between the net percentage of creditors reporting tighter standards for Commercial and Industrial loans and high-yield spreads for the period May 1990–August 2003. For the period November 1991–August 2003 the correlation between high-yield spreads and the reported demand for Commercial and Industrial loans by large and medium-sized companies is at -0.84.

Industrial production (IP) is another lagging indicator. Arobust relationship between high-yield spreads and industrial production is found at 0.76 with a 5–6 month lag. This means that a spread tightening in the high-yield market will induce an improvement in industrial production in a couple of months and give high-yield investors some comfort that spreads will be supported further in the future by better macroeconomic data like industrial production.

Industrial production is compared with default rates. A better IP is associated with increased profitability and cash flow situation of companies. This implies a better access to the capital markets and therefore lowers liquidity risk. As a result default rates will fall when IP rises and this translates directly into tighter spreads.

A robust negative correlation of around 0.75 exists between Moody’s trailing 12-month issuer-based default rate and the US year-over-year production for the period 1988–2003.