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.

Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Last week, Treasury prices fell for the sixth consecutive week, their longest slide since 2005, although they dropped at a more modest pace than the prior week's rout. For the week, the two-year note yield gained four basis points to 5.03%, while the benchmark 10-year yield increased five basis points to 5.16%, and the 30-year yield rose five basis points to 5.26%. Bond prices move inversely to yields.

The week opened with the prior week's selling spilled over into Monday's session. Hawkish comments by the Cleveland Fed President pressured longer-dated maturities. While the two-year yield remained flat, the 10-year yield increased five basis points to 5.15%. Selling continued on Tuesday. Rapidly increasing global growth brought concerns of higher interest rates, and the 10-year yield climbed to 5.27%, the highest in five years.

Relief came on Wednesday. Buyers stepped in amid a higher retail sales report and benign data from the Fed's Beige Book. The 10-year yield fell nine basis points to 5.21%, back below the Fed's 5.25% target rate for overnight loans between banks, and the 30-year shed 11 basis points to yield 5.29%.

Yields returned to their upward climb on Thursday. Signs of climbing wholesale inflation in the producer price index report caused 10-year note yields to rise to 5.22%, while weak Wall Street earnings helped provide support. A tame reading on consumer inflation, together with weak industrial output figures and slipping consumer sentiment, helped push Treasuries higher on Friday. The 10-year yield declined six basis points to 5.26%.

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

• The U.S. Treasury sold $8 billion in 10-year notes on Tuesday, at a higher-than-expected yield of 5.23%.
  
  
• PIMCO Chief Investment Officer Bill Gross reiterated his forecast of a forthcoming rate cut in a "schizophrenic" market within six months or more.
  
  
• A judge in Italy indicted Citigroup (NYSE:C), UBS (NYSE:UBS), Deutsche Bank (NYSE:DB), and Morgan Stanley (NYSE:MS) on criminal charges in connection with the bankruptcy of Parmalat in 2003, which could result in a large payout for defrauded bondholders.
  
  
• The Federal Reserve Bank of New York warned Treasury traders to behave according to guidelines aimed at ending manipulative trading practices, or else provoke additional regulation.
  
  
• Corporations issuing debt included:
• Atmos Energy (NYSE:ATO) sold $250 million in 10-year notes.
• Bank of America (NYSE:BAC) sold $1 billion of debt in a two-tranche offering of 10-year notes.
• Freddie Mac (NYSE:FRE) sold $1 billion in two-year reference notes and $3 billion in five-year reference notes.
• Hewlett-Packard (NYSE:HPQ) sold $2 billion of debt in a two-tranche offering of two- and three-year notes.
• HSBC Finance, a unit of HSBC Holdings (NYSE:HBC) sold $1 billion in five-year global notes.
• Molson Coors Brewing (NYSE:TAP) sold $500 million in six-year convertible notes.
• National Semiconductor (NYSE:NSM) sold $1 billion of debt in a three-tranche offering of senior floating-rate, five, and 10-year notes.

Hot tip
Sometimes even the brightest minds get a bit perplexed. Former Fed Chair Alan Greenspan felt that way in February 2005, when he reflected on the behavior of 10-year Treasuries.

Greenspan was baffled that benchmark yields stayed basically flat with shorter-term yields, or lagged them, despite the Fed's campaign to increase the overnight bank lending rate. He believed that purchases by foreign governments accounted for some of that price action. Indeed, foreign buying of Treasuries surged over recent years, with purchases totaling a record $2.2 trillion as of March.

Greenspan's puzzle is now unraveling. The 10-year yield now exceeds that of the two-year by 13 basis points. Accelerating economic growth, along with global capital seeking higher returns in other venues, has contributed to the recent steepening of the yield curve. That trend may prevail for some time, as evidenced by diminishing foreign interest in recent Treasury auctions. Greenspan isn't worried about that; he opined in a speech last week that yields are in a "cyclical upturn" and will go higher.

It's nice that Greenspan feels better, but is there anything for individual investors to worry about? Not really, if one adheres to a rational asset allocation plan. Current rates remain low by historical standards, and they're unlikely to spawn a bear market in equities due to competing returns. In fact, cyclical sectors such as basic materials companies could benefit in that environment. But if rates do keep climbing, their effect will be felt in higher borrowing costs. That means more pain for the housing market, and perhaps a quieter period for the private equity buyout crowd, whose buyout deals have been fueling recent stock market gains.

Bank of America is a Motley Fool Income Investor recommendation. Take a free 30-day trial to discover more high-yielding investments.

Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since she served 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.