What are investment-grade bonds?
Investment-grade corporate bonds are debt instruments rated BBB- and above by ratings major Standard & Poor’s. Other ratings agencies have their own scales of rating corporate bonds as investment-grade. Treasuries are also considered to be investment-grade.
Funds such as the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) can help you to invest in these instruments. These funds invest in the high-grade corporate bonds of companies such as Verizon Communications (VZ), Goldman Sachs (GS), and Apple (AAPL).
According to the BofA Merrill Lynch US Corporate Master Effective Yield, high-grade bond yields have risen since the beginning of 2016 and have been impacted by oil’s price volatility and China’s economic slowdown. From March onward, however, yields have fallen due to the Federal Reserve’s dovish outlook on the rate hike and uncertainty over Brexit.
Following the Brexit vote, yields have been going downhill. However, the current low level of corporate bond yields remains attractive to foreign investors. Around $12 trillion worth of global debt, mainly concentrated in Japan and Europe, is trading below 0%.
Last week, high-grade bond yields rose after upbeat US inflation and retail sales data raised the possibility of a rate hike by the year’s end. For the week ended July 15, 2016, yields rose by nine basis points and ended up at 2.9%.
Meaning and importance of spreads
The BofA 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 that are rated BBB- or higher on S&P’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. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.
How have spreads moved?
Spreads rose in January, and they rose sharply at the beginning of February due to oil’s price volatility and the general economic slowdown, particularly in China. From March onward, however, spreads fell as fears of a recession in the US economy faded due to upbeat economic growth and improvements in the labor market.
June saw a rising trend in spreads, and following the Brexit vote, spreads jumped due to global uncertainty and rising fears of a global recession. However, since the beginning of July, the spread has been falling as the US economy has been chugging forward. Spreads fell further by eight basis points and ended at 1.5% on July 15, 2016—their lowest level year-to-date (or YTD). Meanwhile, spreads have fallen by 24 basis points YTD.
In the next article, we’ll look at the deals and volumes of investment-grade corporate bonds.