What are investment-grade bonds?
Mutual funds like the Vanguard Total Bond Market Index Fund – Investor Class (VBMFX) help you to invest in investment-grade bonds. VBMFX invests in the 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
According to the BofA Merrill Lynch US Corporate Master Effective Yield, bond yields hovered in the range of 2.84%–3.70% in 2015. Yields fell from January 2015 to mid-April. By mid-April, investment-grade corporate bond yields had fallen to a low of 2.84%. The fall was mainly due to turbulence in European markets as a result of the economic crisis in Greece. This led to a rise in safe-haven demand for investment-grade bonds.
But from the end of April on, yields showed rose a bit. The rise continued until mid-May, though they stayed lower than they had been in 2014. June broke the trend, and yields rose until October. The main reasons responsible for the rise in yields were the possibility of an interest rate hike by the Federal Reserve and an uncertain global growth outlook coupled with a slowdown 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.
In December, yields rose. They hit a high of 3.70% on December 29. This wasn’t just the highest level in 2015. It was also the highest level since January 25, 2012. Yields ended December at 3.68% on December 31, 2015.
Why spreads matter
The BofA Merrill Lynch Option-Adjusted Spread (or OAS) measures the average difference in yields between investment-grade bonds and Treasuries. The securities selected for calculating this spread are rated BBB- or higher on S&P’s rating scale.
If spreads are rising or widening, credit conditions are usually worsening. Spreads also widen when growth is slow and economic conditions worsen. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved in 2015?
In 2015, spreads fell until April’s end. But they rose in subsequent months. In 2015, spreads ranged between 1.29% and 1.80%. In 2014, spreads had ranged between 1.06% and 1.51%. The OAS had averaged 1.50% in January 2015. The average fell in February, March, and April to 1.43%, 1.35%, and 1.33%, respectively. 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, 1.72% in October, 1.62% in November, and 1.70% in December.
Spreads rose pretty much constantly in 2015—except from the last week of October to the first week of December, when they fell. Spreads hit a high of 1.80% on October 2. This was the highest level since September 11, 2012. Meanwhile, on a year-over-year basis, spreads were up 29 basis points. They ended at 1.73% on December 31, 2015. The rise in spreads shows that the risk of high-grade bonds relative to Treasuries has increased.
In the next article of this series, we’ll look at the highest quarterly and monthly issuance for investment-grade corporate bonds.