Question

what would you expect to happen to the spread between yields on commercial paper and treasury bills if the economy were to enter a steep recession.

Answer 1

If there is a steep recession in the economy, I would expect the spread to widen between commercial paper and treasury bills. During a steep economic recession, corporates and banks tended to look for longer term deals and bonds because this allowed corporates to dispense with the continous raising of funds using commercial paper and treasury bills. The spread between these money market instruments depends on the rating of the corporates and its performances. Generally commercial paper shows a positive spread but in recession yield curves would become negative. Yields on short term instruments would rise relative to long term papers but corporate yield rises higher than T-bills, widening its spread, given that during a recession even if government issues more debt, credit risks increases more than proportionally, shows an even higher yield than treasury bills.