Conditions continue to remain favorable for corporate bond investment performance with 1) strong corporate earnings, 2) low inflation, 3) expectations for relatively steady interest rates, especially for longer-dated maturities, and 4) historically narrow corporate bond bid/ask spreads.
While much has been made about the inevitability of rising interest rates, you’ll see from the below chart that yields on US Treasurys from 10 to 30 years are all lower than they were four years ago.
US Treasury Yield Curve: July 31, 2013 vs. July 31, 2017
Source: US Treasury Department
There are two primary reasons for this. First, yields on US Treasurys remain much higher than other countries’ government bonds according to data from Tradeweb:
10-Year Government Bond Yields:
- United States: 2.30%
Foreign governments and investors are the largest holders of US Treasury debt, owning $6.1 trillion, or 43%, of the $14.3 trillion publicly held US Treasury debt on May 31. With US Treasurys being the “best house on the block” in terms of yield, demand for US Treasury notes and bonds has been strong, especially among foreign investors. This has kept prices and yields for US Treasury notes and bonds stable, a trend we expect to continue.
Second, US inflation remains below the 2% Federal Reserve target, which helps increase demand for Treasury notes and bonds as less of their yield is eroded away by higher consumer prices.
As we have been evaluating new corporate bond investment opportunities, we continue to see the benefit of investing in a select number of corporate bonds that are priced favorably relative to other comparable corporate bonds. We will share our next group of investment recommendations at the September 26th premier of The Bondcast. Click here to see a preview video and to register.
Bond Investing 101: How Moves in US Treasurys Impact Corporate Bonds
So why are people so focused on Federal Reserve and other central bank policy when it comes to corporate bonds? When traders set investment-grade corporate bond bid and offer quotes, they generally do so as a spread to the comparable Treasury bill, note or bond's yield. Consider the following example of a Ford Motor Company bond, which pays a 5.291% coupon and matures on 12/8/46, approximately 30 years from now:
|Spread to 30-year
|Ford 5.291% 12/8/46||102.675 / 103.049||5.112% / 5.089%||2.22% / 2.20%|
If you purchase this Ford bond at 103.049, your yield to maturity would be 5.089%, which is 2.20 percentage points higher than the 2.89% yield on the 30-year US Treasury bond. This 2.20% is the “credit spread” and represents the extra interest a bondholder receives above the “risk-free” Treasury yield. Investors should think of the yield of an investment-grade corporate bond to have two pieces: the yield on the comparable US Treasury plus the credit spread. Therefore, since the yield on US Treasurys is embedded into the yield of investment-grade corporate bonds, a change in the yield of the 30-year US Treasury bond would impact the price and yield of the Ford bond assuming no change in credit spreads.
Note that high-yield bonds work differently, as, when Treasury yields rise, it generally means the economy is improving and, with that, there should be fewer defaults on high-yield bonds. When this happens, credit spreads can narrow, which would positively impact the price of the bond. Also, high-yield corporate bonds generally have shorter durations than investment-grade corporate bonds, which helps further protect them from interest rate risk. For more information on the differences between investment-grade and high-yield corporate bonds, view BondSavvy’s Crash Course on Corporate Bond Investing here.
 While a trader prices an investment-grade corporate bond based on a spread to Treasurys, individual investors seeing a bond price quoted from their broker will still see the quote converted to a dollar-price quote. For example, a dollar price quote of 98 indicates the market value of the bond is $980 or 98% of the $1,000 par value.