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 an investment-grade bond. Treasuries are also considered investment-grade instruments.
Mutual funds like the Vanguard Total Bond Market Index Fund – Investor Class (VBMFX) help you to invest in these instruments. VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), Verizon Communications (VZ), Goldman Sachs Group (GS), Cisco Systems (CSCO), and Home Depot (HD).
According to the BofA Merrill Lynch US Corporate Master Effective Yield, yields hovered in the range of 2.84%–3.70% in 2015. In 2015, yields experienced numerous ups and downs due to global market developments. It had touched the low of 2.84% in mid-April, primarily because of turbulence in European markets due to the economic crisis in Greece. In turn, this led to a rise in safe-haven demand for investment-grade bonds.
In December 2015, yields rose and touched a high of 3.7% on December 29. This was not just the highest level in 2015, but it was also the highest level since January 25, 2012. The major reasons for the rise in yields were the interest rate hike by the Federal Reserve on December 15, the uncertain global growth outlook, and the slowdown and rising uncertainty in China.
January 2016 started with falling yields as uncertainty in the Chinese economy and declining oil prices again gripped global markets. The investment-grade bond yield ended at 3.6% on January 14, 2015, 1 basis point higher week-over-week.
Meaning and importance of 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 the ones that are rated BBB- or higher on S&P’s 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 have spreads moved in 2015?
In 2015, spreads fell until the end of April, but they rose in subsequent months. In 2015, spreads ranged from 1.29%–1.80%. The OAS had averaged 1.5% in January 2015. The average fell in February, March, and April to 1.43%, 1.35%, and 1.33%, respectively.
However, from May onward, 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 1.7% in December. Spreads touched a high of 1.8% on October 2, which was the highest point since September 11, 2012.
From January 7–January 14, 2016, spreads rose by 9 basis points and ended at 1.84% on January 14—the highest since September 6, 2012. Meanwhile, spreads are up 29 basis points year-over-year compared to the end of December 2015.
In the next article, we will look at the deals and volumes of investment-grade corporate bonds.