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 “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 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 were 2.84%–3.70% in 2015. Yields saw many ups and downs due to the Greek economic crisis, uncertain global growth outlook, slowdown and rising uncertainty in China, and interest rate hike by the Fed.
In January 2016, yields averaged 3.62%. They mainly rose due to oil price volatility and China’s economic slowdown. With the rebound in oil prices, investment-grade corporate bond yields fell last week. They ended at 3.63% on February 19, 2016—four basis points lower than the previous week.
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. Securities selected for calculating this spread are the ones that are rated BBB- or higher on Standard & Poor’s rating scale.
If spreads are rising or widening, credit conditions are assumed to be worsening. Spreads also widen when growth is slow and economic conditions are worsening. In contrast, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved?
In 2015, spreads were 1.29–1.80%. In January 2016, the OAS averaged 1.88%.
The spreads have widened. This means that investors are demanding higher yields because the risks on those bonds have increased. It raises doubts about the health of the economy. It also increases the company’s cost to raise debt from the market. Overall, this impacts the supply of credit and economic growth.
The spreads ended at 2.15% on February 19—five basis points lower than the previous week. Meanwhile, the spreads rose by 42 basis points year-to-date.
In the next part, we’ll look at the deals and volumes of investment-grade corporate bonds.