Investor 007's Bond Dossier

Meet Investor 007. His specialty? Bonds. Fixed-income bonds.

Don't be fooled by their low-profile reputation. Beneath that cunning disguise, bonds are sophisticated tools to help safeguard your portfolio from the perils of riskier investments. Here's the latest intelligence on their high-stakes world. If you're new to the game, get briefed on the basics of Investor 007's business, or check out our Bond Center for some useful gadgets to help ensure a successful investing mission.

Spying on rates
The benchmark U.S. Treasuries are key rates to keep under surveillance. Corporate issues are generally priced at a spread to a Treasury rate with a similar term, based on the issuer's credit rating.

U.S. Treasury

Price

Yield

Two-year

$100 6/32

4.56%

Five-year

$100 8/32

4.60%

10-year

$97 31/32

4.80%

30-year

$97 6/32

4.95%

Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Treasury prices moved higher for the third consecutive week, surging again on widening credit concerns, as Treasuries marked their largest weekly advance in four months. For the week, the two-year note yield fell 20 basis points to 4.56%, while the benchmark 10-year yield dropped 15 basis points to 4.80%, and the 30-year yield slipped 11 basis points to 4.95%. Bond prices move inversely to yields.

The week began quietly, with a lack of economic releases leaving Treasuries largely unchanged on Monday. Poor corporate earnings on Tuesday gave way to a 230 point drop in the Dow and subsequent Treasury purchasing. The 10-year yield dropped 4 basis points to 4.92%. Treasuries remained little changed on Wednesday, following weak data on existing home sales and the postponements of several debt financings.

The next two days brought sharp gains for Treasuries amid equity pain. A steep sell-off in stocks sent Treasury yields tumbling on Thursday. Purchasers pursued the safety of Treasuries amid a weak new home sales report and continuing credit repercussions and liquidity concerns stemming from the subprime market. The yield curve steepened, with the two-year yield fell 15 basis points to 4.57% and the 10-year yield falling 10 basis points to 4.80%. As equities continued to fall on Friday, Treasuries continued to climb.

Detecting developments
Investor 007 noted the following occurrences in the bond market last week.

  • The U.S. Treasury conducted the following auctions:
    • $6 billion in 20-year TIPS on Tuesday to decent demand at a 2.58% yield.
    • $18 billion in two-year notes on Wednesday at a lower-than-expected yield of 4.735%.
    • $13 billion in five-year notes on Thursday at a higher-than-expected yield of 4.640%.

  • As Treasuries benefited from a flight to safety, the rest of the bond market struggled. Approximately 13 companies withdrew or delayed debt offerings worth more than $33 billion this week, including postponement of a sale of $3.1 billion of loans in connection with the LBO of Allison and a canceled bond offering from Tyco Electronics (NYSE: TEL  ) .

  • Derivatives indexes reflected the increasing riskiness of owning corporate bonds, particularly those of Wall Street banks, because of concerns about their failure to sell corporate loans.

  • Moody's said in a report that a liquidity crunch is inevitable for low-rated domestic companies.

  • Companies issuing debt in the public market included the following:
    • Comerica (NYSE: CMA  ) sold $150 million in three-year senior floating rate notes.
    • Freddie Mac (NYSE: FRE  ) sold $1.5 billion each of three-month and six-month reference notes and $1 billion in one-month bills.
    • InterGen sold $1.875 billion in 10-year high-yield bonds in dollars, euros, and sterling. The deal was held over from the prior week and reduced in size by $100 million.
    • Kimberly Clark (NYSE: KMB  ) sold $2.1 billion of debt in a three-tranche offering consisting of three, 10, and 30-year securities.

Hot tip
As the summer rolls on, the economic outlook from here calls for sustained, modest growth. According to midyear survey of the Securities Industry and Financial Markets Association's Economic Advisory Roundtable, the pace of U.S. economic growth should accelerate through the end of the year and into 2008.

A majority of the group expects the Federal Reserve to leave the key interest rate unchanged for at least the balance of the year and into the next. Most believe that the threat of inflation remains a concern. The median forecast calls for the 10-year Treasury yield to rise modestly during the third quarter, and to 5.25% at year's-end, while holding steady in 2008. The two-year yield is projected to be 5.06% at the end of the third quarter, 5.10% at the end of the year, and 5% in June 2008. The yield curve is expected to be positively sloped, and the group predicts a gradual moderation of foreign investor capital into Treasuries.

On the corporate front, bond credit spreads are expected to widen for both high-yield and investment-grade sectors. Most panelists did not expect a significant "blowout" from current levels, at least on the investment-grade side. That view is based on anticipated moderation in economic and corporate profit growth, the cumulative effect of increased leverage, slowly rising default levels, and eventual increased investor risk sensitivity.

The board foresees continued demand from investors, both foreign and domestic, spurred by heightened risk tolerance, and the strong corporate cash levels built up during heavy profit levels. The Moody's A-Rated Corporate Bond Index is expected to be 5.95% at the end of September, 6.02% at the end of December, and increasing to 6.23% in March 2008. It should then decline to 6.18% for the next two quarters.

Of course, June 18 marked the end of the survey period, at which time the 10-year yield stood at 5.14%. Given last week's Treasury performance, don't place any bets based on this forecast.

Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since she served in banking and legal capacities covering debt underwriting and as fixed-income derivatives. She owns U.S. Treasuries and shares of the Fidelity Inflation Protected Bond Fund. She prefers her portfolio shaken, not stirred. The Fool's disclosure policy only lives twice.


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