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 PIMCO Total Return Fund – Class A (PTTAX) and ETFs such as the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) help you invest in these instruments. PTTAX invests in investment-grade corporate bonds of companies such as Wells Fargo (WFC), Bank of America (BAC), and UBS Group AG (UBS). LQD invests in high-grade corporate bonds of Credit Suisse AG (CS), Verizon (VZ), Goldman Sachs (GS), Apple (AAPL), and General Electric (GE).
According to the BofA Merrill Lynch US Corporate Master Effective Yield, high-grade bond yields averaged 3.6% in January 2016. They rose mainly due to oil price volatility and China’s economic slowdown. In February, yields averaged 3.6%. They were mostly down as oil prices stabilized and equity markets rebounded. In March, yields fell sharply after the Fed’s dovish outlook on the rate hike. They averaged 3.4%. In April, the downward trend in yields continued due to weak corporate results and no strong guidance by the Fed on a rate hike. April’s average came in at 3.2%—the lowest so far in 2016. Meanwhile, yields averaged 3.3% in 2015.
Last week, investment-grade bond yields fell marginally by 2 basis points and ended at 3.0% on May 13, 2016. Upbeat retail sales and consumer confidence data painted a brighter picture of the US economy. However, a fall in yields shows what the bond market thinks. While the US economy is proving to be better than expected, growth still remains low.
Meaning and importance of spreads
The BofA Merrill Lynch 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 can be assumed to be worsening. Spreads also widen when growth is slow and economic conditions are getting worse. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved?
In January, February, March, and April 2016, the option-adjusted spread averaged 1.9%, 2.1%, 1.8%, and 1.6%, respectively. In 2015, the spreads averaged 1.50% in January, 1.4% in February, 1.4% in March, and 1.3% in April.
In January and until February 17, the spreads rose consistently. This indicated that investors were demanding higher yields because the risk on those bonds had increased. The spreads saw a continuous decline. Fear of a recession in the US economy faded. The economy showed signs of improvement.
Last week, the spreads were up by 1 basis point. They ended at 1.6% on May 13, 2016. Meanwhile, the spreads are down by 16 basis points on a year-to-date basis.
In the next part, we’ll look at the deals and volumes of investment-grade corporate bonds.