Flight To Junk
The spread between junk and Treasuries has narrowed signaling that the panic's over.

For the first time since the collapse of Lehman Brothers last year, the typical junk-rated company no longer looks like its about to fall into bankruptcy. The average junk bond lost its “distressed” label last week, when junk yields over comparable Treasurys fell below 10 percentage points – the standard measure of a distressed bond.

The same run of good news that has helped stock markets rally has also given credit markets a lift, said Bill Stone, chief investment strategist at PNC Wealth Management. June house sales, and companies such as Ford Motor ( F - news - people) posting surprisingly strong earnings have given some investors the sense that the economy is on its way to a rebound. Corporate bonds look safer, Stone said, because a growing economy means companies will be more likely to stick around and make their debt payments.

Think of the difference between junk and Treasury yields – a spread -- as a risk premium for junk bonds. It’s the extra reward investors require to buy risky bonds instead of 10-year Treasurys.

Tighter spreads imply that bond buyers are more willing to take a risk, a sign they think the economy is getting healthy. With an average yield of 12.3% on July 24, the junk bond market pays 9.8 percentage points more than Treasurys, according to data from Bank of America ( BAC - news - people ) Merrill Lynch. This spread hit a high of 21.8 percentage points on Dec. 15, a time when financial markets were gripped by fear.

High-yield bonds have climbed 34% since the start of the year and 18% in the last three months. “I still think they make sense even after the recent run,” said Jim Lowell, chief investment strategist at Adviser Investments and a Forbes columnist. Lowell sees junk bonds as a hedge against falling Treasury prices and recommends buying an index fund, such as theiShares IBoxx High Yield Corporate Bond Fund ( HYG -news - people ).

One widely cited explanation for the surge in corporate bond markets and tighter spreads is that investors began selling the Treasury debt they hoarded in the worst of the financial crisis and moved their money into riskier securities. It’s a reversal of the “flight to quality” that saw people ditch other investments last year and plow money into the safest securities, bonds backed by the U.S. Selling Treasury debt pushes those yields higher, as yields move in the opposite direction from prices.

Some worry that inflation fears and the expanding supply of Treasury debt to finance the government’s deficit spending will shove yields up further. The U.S. Treasury plans on selling $109 billion in two, five and seven-year notes on Friday.

Treasury bonds are still well below their average yield. Since 1989, the average 10-year has yielded 5.7%.