What are investment-grade bonds?
Investment-grade corporate bonds are debt instruments that Standard & Poor’s rates as BBB- and above. Other rating agencies have their own scale for rating a corporate bond as investment-grade. Treasuries are also considered investment-grade.
Mutual funds like the Vanguard Total Bond Market Index (VBMFX) help you to invest in these instruments. The VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), American Airlines (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 had fallen from January to mid-April 2015, primarily because of a rise in safe-haven demand for investment-grade bonds, as there was a lot of turbulence in European markets due to the economic crisis in Greece.
By mid-April, yields on investment-grade corporate bonds had fallen to a low of 2.84%. US corporates and financials had thronged the primary bond market in the US due to these low yield levels. However, from the end of April onwards, yields showed a rising trend that continued until mid-May, though their level remained lower than that in 2014.
But June broke the trend and yields have been rising since then. The major reasons responsible for the rise in yields are the possibility of an interest rate hike by the Federal Reserve, uncertain global growth outlook, and rising uncertainty in China. The yields touched a new high of 3.52% on September 16. This was not only the highest level in 2015 year-to-date, it was also the highest level since September 18, 2013.
The 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 that are rated BBB- or higher on S&P’s rating scale.
If spreads are rising or widening, credit conditions can be assumed to be worsening. 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.
How have spreads moved in 2015?
In 2015, spreads had fallen until the end of April, but they rose in subsequent months. As of October 2, spreads had ranged between 1.29% and 1.80%. In 2014, spreads by this measure had ranged between 1.06% and 1.51%.
The OAS had averaged 1.50% in January 2015. The average fell in February, March, and April to 1.43%, 1.35%, and 1.33%, respectively. However, from May onwards, the average OAS began to rise. Spreads averaged 1.34% in May, 1.42% in June, 1.51% in July, 1.65% in August, and 1.69% in September.
Spreads touched a high of 1.80% on October 2. This was the highest since September 11, 2012. Further, spreads are up 36 basis points compared to at the end of December 2014.
In the next article, we will look at the deals and volumes of investment-grade corporate bonds.