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.”
Funds such as iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) and the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) help you invest in these instruments. These funds invest in high-grade corporate bonds of Verizon Communications (VZ), Goldman Sachs (GS), and Apple (AAPL).
According to the BofA Merrill Lynch US Corporate Master Effective Yield, high-grade bond yields rose from the beginning of 2016 and have been impacted by oil price volatility and China’s economic slowdown. From March onwards, yields fell due to the Fed’s dovish outlook on the rate hike and uncertainty about the Brexit vote.
Last week, high-grade bond yields fell sharply due to growing panic and concern about global economic growth as the United Kingdom decided to leave the European Union. For the week ending July 1, the yields fell 9 basis points and ended at 2.9%. The Fed won’t raise rates in the coming months. It’s widely speculated that the Fed might push the rate hike to next year.
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 getting worse. 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?
Spreads were up in January. They rose sharply at the beginning of February due to oil price volatility and a general slowdown—particularly in China. From March onwards, spreads fell as the fear of a recession in the US economy faded due to upbeat economic growth and improvement in the labor market.
June saw a rising trend in spreads. The spreads were flat last week and ended at 1.6% on July 1, 2016. However, there was global economic risk due to the fallout as the United Kingdom voted to exit the European Union. Meanwhile, spreads are down by 11 basis points on a year-to-date basis.
In the next part, we will look at the deals and volumes of investment-grade corporate bonds.