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 such as the Vanguard Total Bond Market Index Fund – Investor Class (VBMFX) help you 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 Bank of America Merrill Lynch US Corporate Master Effective Yield, yields were 2.8%–3.7% in 2015. Yields saw many ups and downs due to the following:
- Greek economic crisis
- uncertain global growth outlook coupled with the slowdown and rising uncertainty in China
- interest rate hike by the Federal Reserve
In January 2016, yields averaged 3.6% and rose mostly due to oil price volatility and China’s economic slowdown.
Last week, investment-grade corporate bond yields fell and ended at 3.6% on February 26, 2016. That was 1 basis point lower than the previous week.
Meaning and importance of spreads
The Bank of America 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 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 worsening. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved?
In 2015, spreads were 1.3%–1.8%. In January 2016, OAS averaged 1.9%.
In January and until February 17, 2016, spreads rose persistently. That means investors are demanding higher yields because the risk on those bonds has increased. It raises doubts about the health of the economy and increases the cost of the company to raise debt from the market. This has an overall impact on the supply of credit and economic growth.
Last week, however, spreads fell and ended at 2.1% on February 26. That’s 4 basis points lower than the previous week. Spreads are up by 38 basis points year-to-date.
In the next article, we’ll look at the deals and volumes of investment-grade corporate bonds.