What are investment-grade bonds?
Investment-grade corporate bonds are debt instruments rated BBB- and above by 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) such as the Vanguard Total Bond Market Index Fund – Investor Class (VBMFX) help you to invest in these instruments. The VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), Verizon Communications (VZ), Goldman Sachs Group (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. By mid-April, investment-grade corporate bond yields had fallen to a low of 2.8%, primarily because of turbulence in European markets due to the economic crisis in Greece, which led to a rise in safe-haven demand for investment-grade bonds.
However, from the end of April through mid-May, yields showed a rising trend despite remaining lower than in 2014. However, June broke that trend, but yields rose again until September. The major reasons for the rise in yields were the possibility of an interest rate hike by the Federal Reserve and the uncertain global growth outlook coupled with rising uncertainty in China.
From September until mid-October, investment-grade corporate bond yields fell but rose again as October ended due to the increased likelihood of a rate hike in December. On November 9, the investment-grade corporate bond yield reached 3.6%, which is not just the highest level in 2015 so far, but also the highest level since September 16, 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 those rated BBB- or higher by Standard & Poor’s.
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 November 13, spreads have been in the range of 1.29%–1.80%. In 2014, spreads ranged between 1.06% and 1.51%. 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. 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, 1.69% in September, and 1.72% in October.
Spreads touched a high of 1.80% on October 2. This was the highest level since September 11, 2012. After that, spreads fell in October. However, last week spreads rose by 1 basis point and ended at 1.63% on November 13. Meanwhile, spreads have risen 19 basis points since the end of December 2014.
In the next article, we’ll look at the deals and volumes of investment-grade corporate bonds.