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Analyzing Investment-Grade Corporate Bond Yields and Spreads

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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 (MFs) like the Vanguard Total Bond Market Index Fund – Investor Class (VBMFX) help you invest in these instruments. VBMFX invests in investment-grade corporate bonds of companies like Apple (AAPL), Verizon (VZ), Goldman Sachs (GS), Cisco Systems (CSCO), and Home Depot (HD).

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Yield movement until October 2015

The yields fell from January to mid-April 2015, according to the BofA Merrill Lynch US Corporate Master Effective Yield. The demand for safe-haven investment-grade bonds rose due to the economic crisis in Greece. The crisis led to turbulence in the European markets. By mid-April, the yields on investment-grade corporate bonds fell to a low of 2.8%. Since the end of April, the yields showed a rising trend. They continued to rise until mid-May. However, the yields remained lower than the level in 2014.

June broke the trend. Yields rose from June through September. The major reasons for the rise in the yields include the possibility of an interest rate hike by the Fed, the uncertain global growth outlook, and rising uncertainty in China.

In October, investment-grade corporate bond yields fell until the middle of the month. They rose in the last week of October after the FOMC (Federal Open Market Committee) policy meeting. The FOMC policy meeting indicated the increased likelihood of a rate hike in December. The investment-grade corporate bonds yields fell month-over-month from 3.43% on September 30 to 3.40% on October 30.

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Meaning and importance of spreads

The BofA Merrill Lynch OAS (option-adjusted spread) measures the average difference in yields between investment-grade bonds and Treasuries. The securities selected for calculating this spread are the ones that are rated BBB- or higher by Standard & Poor’s.

If the spreads are rising or widening, it’s assumed that the credit conditions are getting worse. Spreads also widen when growth is slow and economic conditions are getting worse. In contrast, falling or tightening spreads coincide with faster growth and better economic conditions.

How did the spreads move until October 2015?

In 2015, the spreads fell until the end of April. Then, the spreads rose in the following months. Until October 30, the spreads were 1.3%–1.8%. In 2014, the 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. Since May, the average OAS started to rise. The spreads averaged 1.3% in May, 1.4% in June, 1.5% in July, 1.65% in August, 1.69% in September and 1.70% in October.

The spreads touched a high of 1.8% on October 2. This was the highest level since September 11, 2012. After that, the spreads continued to fall in October. The spreads fell by 13 basis points on a month-over-month basis. They ended lower at 1.7% on October 30.

In the next part, we’ll look at investment-grade corporate bonds’ deals and volumes.

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