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).
Yield movement, so far, in 2015
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 bonds yields fell to a low of 2.8%. This was mainly due to turbulence in the European markets. The turbulence was a result of the economic crisis in Greece. It led to a rise in the safe-haven demand for investment-grade bonds. At the end of April, yields showed a rising trend. This continued until mid-May. However, the level was lower than in 2014.
June broke the trend. The yields rose from June until September. The major reasons for the rise in the yields were the possibility of an interest rate hike by the Fed, an uncertain global growth outlook, and rising uncertainty in China. Until mid-October, the investment-grade corporate bonds yields fell. However, they rose at the end of October due to the increased likelihood of a rate hike in December. In November, the yields rose and touched 3.6% on November 9. This was the highest level YTD (year-to-date) in 2015. It was also the highest level since September 16, 2013.
Why are the spreads important?
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, it’s assumed that the credit conditions are worse. Spreads also widen when growth is slow and economic conditions are worse. In contrast, falling or tightening spreads coincide with faster growth and better economic conditions.
How did spreads move until November?
In 2015, the spreads fell until the end of April. They rose in the following months. Until November 20, the spreads were 1.3%–1.80%. 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 1.4%, 1.4%, and 1.3%, respectively. However, the average OAS started to rise in May. 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 high of 1.80% on October 2. This was the highest level since September 11, 2012. After that, the spreads fell in October. The fall continued in November. Last week, the spreads fell by one basis point and ended at 1.6% on November 20. Meanwhile, the spreads rose by 18 basis points compared to the end of December 2014.
In the next part, we’ll look at the deals and volumes of investment-grade corporate bonds.