What are investment-grade corporate bonds?
Investment-grade corporate bonds are debt instruments rated BBB- and above by rating major Standard & Poor’s. Other rating agencies have their own scale of rating a corporate bond as investment-grade. Treasuries are also considered investment-grade.
Mutual funds such as the Vanguard Total Bond Market Index Fund (VBMFX) help you invest in these instruments. VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), American Airlines Group (AAL), Nike (NKE), and General Electric (GE).
Yield movement in 2015 so far
According to the BofA Merrill Lynch US Corporate Master Effective Yield, yields fell until mid-April 2015. This was primarily because of a rise in demand for safe-haven bonds amid a lot of turbulence in European markets due to the economic crisis in Greece. Yields on investment-grade corporate bonds fell to a low of 2.84% by mid-April.
US corporates and financials thronged the primary bond market in the United States due to these low yield levels. Since the end of April, yields showed some rising trend and continued until mid-May, although their levels remained lower than 2014 levels.
But June broke the low-level trend, and yields have been rising since then. The two major reasons for the rise in yields are the possibility of an interest rate hike by the Federal Reserve and less demand for safe havens, since European markets have stabilized due to Greece’s bail-out deal. Yields rose as high as 3.46% on August 26. This was not only the highest level in 2015 year-to-date, but it was also the highest level since September 18, 2013.
Meaning and importance of spreads
The BofA Merrill Lynch Option-Adjusted Spread (or OAS) measures the average difference in yields between investment-grade bonds and Treasuries. Securities selected for calculating this spread are the ones rated BBB- or higher on the Standard & Poor’s rating scale.
If spreads are rising or widening, we can assume that credit conditions are getting worse. Spreads also widen when growth is slow and economic conditions are worsening. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.
Spreads in 2015
Until August 2015, spreads ranged from 1.29%–1.72%. In 2014, spreads by this measure ranged from 1.06%–1.51%. Year-to-date in 2015, spreads fell until the end of April and started to rise in May, June, July, and August.
The OAS averaged 1.50% in January 2015. The average fell in February, March, and April to 1.43%, 1.35%, and 1.33%, respectively. In May, the average OAS began to rise. Spreads averaged 1.34% in May, 1.42% in June, 1.51% in July, and 1.65% in August. Spreads are up 25 basis points compared to the end of December 2014.
In the next article, we’ll look at the deals and volumes of investment-grade corporate bonds.