In our outlook for last quarter we mentioned that we were positive on investment grade corporate bond credit spreads* coming into the third quarter because we believed that a strong technical backdrop would be the primary determinant of how the market would perform. And this was, in fact, the case. Corporate financial fundamentals were decent, but mixed. Credit spreads were attractive to us, though absolute yield levels were well below the five-year average. Nonetheless, market technicals remained incredibly strong. This was due in large part to strong overseas demand for U.S. corporate bonds given their relatively attractive yield compared to foreign bond markets where yields are close to zero, if not negative. Consequently, investment grade corporate bond spreads continued their tightening trend during 3Q2016, reaching year-to-date tights during August before backing off slightly in September. The Bloomberg Barclays US Corporate Index tightened 18 basis points (bps) to end the quarter at an Option-Adjusted Spread (OAS) of 138.1
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1Option-adjusted spread is the spread relative to a risk-free interest rate, usually measured in basis points (bp), that equates the theoretical present value of a series of uncertain cash flows of an instrument to its current market price.OAS can be viewed as the compensation an investor receives for assuming a variety of risks (e.g. liquidity premium, default risk, model risk), net of the cost of any embedded options. A larger OAS implies a greater return for greater risks.