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 scales for rating corporate bonds as investment-grade. Treasuries are also considered investment-grade.
Mutual funds such as the Vanguard Total Bond Market Index Fund – Investor Class (VBMFX) help you invest in these bonds. VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), Verizon Communications (VZ), Goldman Sachs Group (GS), Cisco Systems (CSCO), and The Home Depot (HD).
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. This is due primarily to a rise in the safe-haven demand for investment-grade bonds while there was turbulence in the European markets over the economic crisis in Greece.
By mid-April, investment-grade corporate bond yields fell to a low of 2.8%. US corporates and financials had thronged the primary bond market in the United States due to these low-yield levels. However, at the end of April, yields began to show a rising trend, which lasted until mid-May. Their levels still were lower than the 2014 levels.
But June broke the trend, and yields have been rising ever since. The major reasons for the rise in yields are the possibility of an interest rate hike by the Federal Reserve and an uncertain global growth outlook coupled with rising uncertainty in China. Yields touched 3.5% on September 16. It was not only the highest level in 2015 year-to-date but also the highest level since September 18, 2013.
So far in the month of October, investment-grade corporate bond yields have been falling due to low expectations of a rate-hike this year and growing global uncertainty.
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 that are rated BBB- or higher on the Standard & Poor’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 did spreads move before October 2015?
In 2015, spreads fell until the end of April, but they rose in subsequent months. Until October 23, spreads were 1.3%–1.8%. In 2014, spreads by this measure were 1.1%–1.5%.
The OAS averaged 1.5% in January 2015. The average fell in February, March, and April to 1.4%, 1.4%, and 1.3%, respectively. However, in May, the average OAS began to rise. Spreads averaged 1.3% in May, 1.4% in June, 1.5% in July, 1.7% in August, and 1.7% in September.
Spreads touched a high of 1.8% on October 2, the highest since September 11, 2012. Since then, spreads have been falling. They ended at 1.7% on October 23. But spreads are up 23 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.