With percentage yield spread analysis, we divide the yields on corporate bonds by the yields on Treasuries with the same duration (yield on corporate bond / yield on Treasury). If the ratio is higher than justified by the historical ratio, the spread is expected to fall, making corporate bond prices rise.
If the ratio is high, wouldn’t we want the corporate bond price to fall so that the ratio falls?
I don’t think so. Corporate bonds are the numerator, treasuries are the denominator, so for that ratio to come back in line with historical, we need to see the yields on corporate bonds go down. Here is a simple example of how I’m thinking about it
Corporate Bonds Yields: 10.00%, Treasury Yields = 2.00%, Ratio is (10.00% / 2.00%) = 5
If the historical ratio is 4, than yields on corporate bonds should fall to 8.00%, and prices on corporate bonds should go up.
Price = k*1/yield. where k is some random dynamic number.
If price goes down, then yield goes up, then ratio goes…?