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

2-year

$100 13/32

4.40%

5-year

$100 19/32

4.48%

10-year

$98 19/32

4.67%

30-year

$98 8/32

4.86%

Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Treasury prices moved higher for the fourth consecutive week, surging again on widening credit concerns, as financials felt the subprime fallout. For the week, the two-year note yield fell 10 basis points to 4.67%, while the benchmark 10-year yield dropped 9 basis points to 4.67%, and the 30-year yield slipped 7 basis points to 4.86%. Bond prices move inversely to yields.

With an absence of economic news, bargain hunters poured cash into equities on Monday. As stocks climbed, Treasuries endured their largest decline in two weeks. The two-year yield pushed up 7 basis points to 4.57%, and the 10-year yield rose 5 basis points to 4.81%. The tide changed on Tuesday, as continuing subprime and equity losses encouraged Treasury purchasers. The 10-year yield dropped 7 basis points to 4.74%, its lowest level since May. Prices declined on Wednesday following a reported increase in pending home sales and stabilization in the stock market.

Treasuries rallied the next two days. On Thursday, prices rose following choppy trading focused on the same credit concerns. Both the two-year and 10-year yields slipped 1 basis point to 4.57% and 4.77%, respectively. A rating downgrade of Bear Stearns (NYSE: BSC  ) on Friday, coupled with negative remarks on the credit market's health from a top executive, sparked a sell-off in stocks. Treasuries benefited from a flight to quality, as well as from a soft July employment report. The two-year yield plummeted 17 basis points, while speculation increased that the Fed will cut interest rates before the end of the year. The Federal Reserve is expected to leave rates unchanged at this week's Federal Open Market Committee meeting, but its policy statement will be parsed for signs of future action.

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

  • The U.S. Treasury announced that it will auction $13 billion in 10-year notes on Wednesday and $9 billion in 29 3/4-year bonds on Thursday, in its smallest quarterly auction since 2001.
  • The New York Fed published a study stating that the U.S. bond market is losing growth to the Eurobond market.
  • American Home Mortgage (NYSE: AHM  ) said on Tuesday that it may have to liquidate assets to meet obligations, and late Thursday, it announced it would close all operations except its thrift and servicing units the next day.
  • Various reports surmised that American International Group (NYSE: AIG  ) may endure losses from $1.4 billion to $2.3 billion thanks to its holdings of securities linked to subprime mortgages.
  • An individual investor filed an arbitration claim against Bear Stearns for allegedly misleading investors about its exposure to subprime mortgages. Separately, Standard & Poor's cut Bear's debt-rating outlook to negative. On Friday, the CFO of Bear Stearns heightened market jitters by commenting that the credit market was "as bad as I've seen it" in his 22 years.
  • The risk of owning corporate bonds, as measured by credit default swaps, rose in the U.S. and Europe.  
  • Lehman Brothers (NYSE: LEH  ) announced that it will launch a new derivative product allowing investors to take positions on muni bonds.
  • Morgan Stanley (NYSE: MS  ) will reportedly be fined $6.1 million by the Financial Industry Regulatory Authority for allegedly overcharging customers in bond sales.
  • Standard & Poor's said an additional $1 billion of collateralized debt obligations may be downgraded.
  • Sparse corporate issuance in the public market included the $450 million sale of two-year floating rate notes by Coca-Cola Enterprises (NYSE: CCE  ) , in an offering increased from $300 million.

Hot tip
If you want to take a bite out of the Big Apple, the city's recent bond offerings may be worth a munch or two.

On July 25, in connection with a refinancing of higher-interest bonds, New York City offered $919 million securities due from 2021 through 2026 through underwriter Morgan Stanley. According to Bloomberg, bonds maturing in 19 years were priced to yield 4.51%, nine basis points higher than the Municipal Market Advisors index of top-rated bonds.

Strong demand prompted the city to expand its offering twice from its original plans. The city's highest credit ratings in its history attracted purchasers, including funds and insurers as well as individual investors. The bonds are rated AA by Standard & Poor's, Aa3 by Moody's, and Aa3 by Fitch.

A sale of auction-rate bonds in a four-tranche offering is also planned on or near Aug. 9. For those seeking the tax savings of muni bonds, NYC's relative safety makes investing in its securities an appetizing option.   

Can't get enough fixed-income news? Check out Income Investor free for 30 days.

Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since serving in banking and legal capacities covering debt underwriting as well 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. Moody's is a Stock Advisor recommendation. The Fool's disclosure policy never goes undercover.


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