What’s an investment-grade bond?
An investment-grade corporate bond is a debt instrument rated BBB- and above by rating major Standard & Poor’s. Other rating agencies have their own scale of rating a corporate bond as an investment-grade bond. Treasuries are also considered “investment-grade.”
Mutual funds 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 Communications (VZ), Goldman Sachs (GS), Cisco Systems (CSCO), and Home Depot (HD).
Yield movement in 2015
According to the BofA Merrill Lynch US Corporate Master Effective Yield, yields fell from January to mid-April 2015. They fell mainly because of a rise in safe-haven demand for investment-grade bonds. There was turbulence in the European markets due to the economic crisis in Greece.
By mid-April, yields on investment-grade corporate bonds fell to a low of 2.8%. US corporates and financials thronged the primary bond market in the US due to these low yield levels. Starting at the end of April, yields showed a rising trend. This continued until mid-May, although the level remained lower than the level in 2014.
However, June broke the trend. Yields rose from June until September. The major reasons for the rise in yields include the possibility of an interest rate hike by the Fed, the uncertain global growth outlook, and rising uncertainty in China. The yields touched 3.5% on September 16. This isn’t just the highest level in 2015 YTD (year-to-date), it’s also the highest level since September 18, 2013.
The investment-grade corporate bonds yields fell until mid-October but rose again at the end of October. The rise was due to the increased likelihood of a rate hike in December.
What are 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 on Standard & Poor’s rating scale.
If spreads are rising or widening, credit conditions are assumed to be 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 have spreads moved until October 2015?
In 2015, spreads fell until the end of April, but they rose in the following months. Until October 30, the spreads were 1.3%–1.8%. In 2014, the spreads were 1.1%–1.5%.
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 started to rise. The 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.
The spreads touched a high of 1.80% on October 2. This was the highest since September 11, 2012. After that, the spreads continued to fall in October. Last week, they ended lower at 1.65% on October 30. However, the spreads are up by 21 basis points compared to the end of December 2014.
In the next part, we’ll look at investment-grade corporate bonds’ deals and volumes.