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 scales for rating corporate bonds as investment-grade. Treasuries are also considered to be investment-grade.
Mutual funds such as the Vanguard Total Bond Market Index Fund Investor Class (VBMFX) can help you to invest in these instruments. The VBMFX invests in investment-grade corporate bonds of companies such as Apple (AAPL), Verizon Communications (VZ), Goldman Sachs (GS), Cisco Systems (CSCO), and Home Depot (HD).
According to the BofA Merrill Lynch US Corporate Master Effective Yield, yields ranged between 2.8% and 3.7% in 2015. Yields saw many ups and downs due to the Greek economic crisis, uncertain global growth outlook, the slowdown and rising uncertainty in China, and the interest rate hike by the Federal Reserve.
In January 2016, yields rose mostly due to oil price volatility and China’s economic slowdown. Investment-grade bond yields fell last week after the Bank of Japan (or BoJ) introduced negative interest rates for the first time to boost economic growth. Yields landed at 3.6% on January 29, 2016, a fall of six basis points 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 those that are rated “BBB-” or higher on Standard & Poor’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 deteriorating. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved?
In 2015, spreads fell until April’s end, but they rose in the subsequent months. In 2015, spreads ranged between 1.3% and 1.8%. The OAS averaged 1.9% in January 2016.
Last week, spreads rose, touching a new high of 2.0%. This was the highest amount since July 18, 2012. They ended at 2.0% on January 29, six basis points higher than in the previous week. Meanwhile, spreads are up 29 basis points year-to-date.
In the next article, we’ll look at the deals and volumes of investment-grade corporate bonds.