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High-Grade Bond Yields Fell, Spreads Rose at the End of July

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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 the 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).

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Yield movement

According to the BofA Merrill Lynch US Corporate Master Effective Yield, high-grade bond yields have risen since the beginning of 2016. They have been impacted by oil price volatility and China’s economic slowdown. Since March, yields have fallen due to the Fed’s dovish outlook on a rate hike and uncertainty about the Brexit vote. Since the Brexit vote, yields have been falling. However, the current low level of corporate bond yields still remains attractive to foreign investors. Around $12 trillion of global debt, mainly concentrated in Japan and Europe, trades below 0%.

In July, yields fell mainly due to the uncertainty created by the Brexit vote. As widely expected, the Fed left the interest rates unchanged in its July 26–27 policy meeting. Also, the meeting didn’t give any clarity about a rate hike. However, it did mention that the US economy was expanding modestly and “near-term risks to the economic outlook have diminished.”

Last week, high-grade bond yields fell after lower-than-expected economic growth data. For the week ending July 29, the yields fell by 6 basis points and ended at 2.8%—the lowest since May 13, 2013.

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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. Conversely, falling or tightening spreads coincide with faster growth and better economic conditions.

How have spreads moved so far?

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. Since March, 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. After the Brexit vote, spreads jumped due to global uncertainty and rising fear of a global recession. In July, spreads fell mostly as the fear from the Brexit vote subsided and the US economy went into a modest expansion mode. Last week, spreads touched the lowest YTD (year-to-date) level of 1.5% on July 25. They ended at 1.50% on July 15, 2016—up by 3 basis points week-over-week. Meanwhile, spreads are down by 23 basis points on YTD basis.

In the next part, we’ll look at the deals and volumes of investment-grade corporate bonds.

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