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Analyzing Investment-Grade Corporate Bond Yields and Spreads

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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 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 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 bond 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.

From the end of April until mid-May, yields showed a rising trend. However, the level remained lower than in 2014. June broke the trend. The yields rose from June until October. The major reasons for the rise in yields were the possibility of an interest rate hike by the Fed, an uncertain global growth outlook, and rising uncertainty in China. October and November saw ups and downs in yields due to the increased likelihood of a rate hike in December.

The yields rose in December. They touched a high of 3.70% on December 29. It was the highest level in 2015. It was also the highest level since January 25, 2012. Investment-grade bond yields ended at 3.7% on December 31, 2015.

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 spreads are rising or widening, it can be assumed that 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.

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How did spreads move in 2015?

In 2015, spreads fell until the end of April. However, they rose in subsequent months. In 2015, the spreads were 1.3%–1.80%. By this measure, the spreads were 1.1%–1.5% in 2014. 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. Since May, the average OAS started to rise. Spreads averaged 1.34% in May, 1.42% in June, 1.51% in July, 1.65% in August, 1.69% in September, 1.72% in October, 1.62% in November, and 1.70% in December.

The spreads touched a high of 1.80% on October 2. This was the highest since September 11, 2012. In November, the spreads were 1.61%–1.65%. In December, the spreads rose consistently. They were up by 11 basis points on a month-over-month basis. They ended at 1.73% on December 31. Meanwhile, on YoY (year-over-year) basis, the spreads rose by 29 basis points on December 31, 2015.

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

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