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, yields averaged 3.6% in January 2016. They rose due to oil price volatility and China’s economic slowdown. Yields also averaged 3.6% in February, but 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. The yields averaged 3.4%. In April, the downward trend in yields continued due to weak corporate results and no strong guidance by the Fed on the rate hike. April’s average came in at 3.2%—the lowest so far in 2016. Meanwhile, yields averaged 3.3% in 2015.
In May, yields were mostly mixed. For the week ending May 27, high-grade bond yields were down by 3 basis points and ended at 3.1% on May 27.
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 can be assumed to be worsening. Spreads also widen when growth is slow and economic conditions are getting worse. In contrast, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved?
In January, February, March, and April 2016, the OAS 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 increased. Then, the spreads saw a continuous decline. The fear of a recession in the US economy faded and the economy showed signs of improvement. The spreads rose marginally in May.
Last week, the spreads were down by 2 basis points and ended at 1.5% on May 27, 2016. Meanwhile, the spreads are down by 19 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.