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Investment-Grade Corporate Bond Spreads Reach New Heights in 2016

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What are investment-grade bonds?

Investment-grade corporate bonds are debt instruments rated BBB- and above by the rating king, S&P (Standard & Poor’s). Other rating agencies have their own scales of rating corporate bonds as investment-grade. Treasuries, for example, are considered investment-grade, and MFs (mutual funds) like the Vanguard Total Bond Market Index Fund Investor Class (VBMFX) help you to invest in these instruments. Specifically, VBMFX invests in investment-grade corporate bonds of companies like Apple (AAPL), Verizon Communications (VZ), Goldman Sachs Group (GS), Cisco Systems (CSCO), and Home Depot (HD).

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Investment-grade bond yield movement as of January 22

According to the BofA Merrill Lynch US Corporate Master Effective Yield, investment-grade bond yields hovered in the range of 2.84%–3.70% in 2015. In 2015, yields saw many ups and downs due to global markets developments. They touched a low of 2.84% in mid-April, 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.

In December, by contrast, yields rose, touching a high of 3.70% on December 29, which was not only the highest level in 2015 but also the highest level since January 25, 2012. Among the major reasons responsible for this rise in yields were the interest rate hike by the US Federal Reserve on December 15 and an uncertain global growth outlook driven by the slowdown and rising uncertainty in China.

January 2016 started with falling yields as Chinese uncertainty and falling oil prices again gripped markets across the global. But due to the volatility in oil prices, investment-grade bond yields rose last week, ending at 3.67% on January 22, 2016—eight basis points higher than the previous week.

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Understanding the meaning and importance of option-adjusted 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 ones that are rated BBB- or higher on the S&P rating scale.

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 has the OAS spreads moved?

In 2015, spreads fell until the end of April and then rose in subsequent months, ranging between 1.29–1.80% on the year. The OAS spread averaged around 1.5% in January 2015, but that average fell in February, March, and April to 1.43%, 1.35% and 1.33%, respectively.

From May onward, however, the average OAS began to rise, and 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 touched a high of 1.8% on October 2, which was its highest level since September 11, 2012.

New heights last week

Last week spreads rose and touched a new high of 1.98% on January 20, which was its highest level since July 27, 2012, ending the week at 1.96% on January 22—seven basis points higher than the previous week. Meanwhile, spreads are up 23 basis points on a year-to-date basis.

In the next part of this series, we’ll look at the deals and volumes of investment-grade corporate bonds that were issued in the week ending January 22.

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