What are investment-grade 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 (or MFs) like the Vanguard Total Bond Market Index Fund (VBMFX) help you to invest in these instruments. The VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), Verizon (VZ), Goldman Sachs (GS), Cisco Systems (CSCO) and Home Depot (HD).
Yield movement in 2015 so far
According to the BofA Merrill Lynch US Corporate Master Effective Yield, yields fell 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 onward, yields showed some rising trend and 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 for the rise in yields are the possibility of a hike in interest rates by the Federal Reserve, an uncertain global growth outlook, and rising uncertainty in China. The yields touched 3.52% on September 16. This wasn’t only the highest level in 2015 year-to-date, but also the highest level since September 18, 2013.
In October, so far, the investment-grade corporate bonds yields have been falling due to low expectations of a rate hike this year.
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 rating scale of S&P.
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 with better economic conditions.
How have spreads moved until October 2015?
In 2015, spreads fell until April’s end but rose in subsequent months. Until October 16, spreads ranged between ~1.3% and 1.8%. In 2014, spreads by this measure had ranged between ~1.1% and 1.5%.
The OAS averaged 1.5% 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 1.8% on October 2. This was the highest since September 11, 2012. However, they ended lower at 1.74% on October 8, last week. Meanwhile, spreads are up 28 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.