Investment-grade bond returns could feel pressure

The yield to worst on investment-grade bonds, measured by the Bloomberg Barclays U.S. Corporate Bond index, rose briefly following the onset of the pandemic in March 2020. At that time, economic concerns helped drive a 100-basis-point increase in the YTW to about 3.4%. Subsequently, the yield fell over the next four months to below 2%, and the 1.7% level in December was the lowest since the index's construction in 1973. The YTW is currently about 2%, lower than pre-pandemic levels.

The index's option-adjusted spread is currently 89 basis points. It was in the 100 to 150 basis points range in the couple of years leading to March 2020, when it temporarily spiked to over 270 basis points by the end of that month. However, the spread has widened during economic downturns, notably during the Great Recession when it swelled to over 600 basis points in November 2008.

The total return on the investment-grade bond index was 0.2% over the last year through Aug. 9, although the longer-term performance is better. Positively, corporate earnings have been strong, the economic data is pointing in the right direction, and the Fed has shown patience in raising interest rates and tapering bond purchases. However, ultra-low interest rates could pressure returns when they turn up. The index's effective duration was 8.5 at the end of June.