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. This time around, Treasury prices moved higher for the second consecutive week, surging on subprime credit concerns, as the benchmark 10-year yield declined by its greatest amount since early March. For the week, the two-year note yield fell 15 basis points to 4.76%, while the 10-year yield also dropped 15 basis points to 4.95%, and the 30-year yield slipped 13 basis points to 5.06%. Bond prices move inversely to yields.

Treasuries opened the week with gains. Longer-dated maturities rose as participants ignored a strong New York manufacturing report, speculating that continuing subprime losses would spur a further flight to quality. The 10-year yield decreased six basis points to 5.04%. Treasuries reversed course on Tuesday, falling in response to a strong earnings report from Merrill Lynch (NYSE:MER), which eased subprime worries. A weak homebuilder confidence figure, but rising industrial production and capacity utilization numbers, limited the rise in the 10-year yield to two basis points.

Fed Chief Bernanke gave his semiannual monetary policy testimony to Congress over the next two days. On Wednesday, his acknowledgment that the weak housing market might slow economic growth helped push the 10-year yield down to 5.03%.

While Bernanke gave identical testimony to the Senate on Thursday, the market reacted differently. Profit-taking trimmed one basis point from the 10-year yield, as a soft regional manufacturing index and greater subprime concerns provided support.

Treasuries resumed their climb on Friday, again assisted by worries that subprime and credit woes would infect other markets.

The 10-year yield sank eight basis points to a six-week low.

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

• The riskiest ABX index of subprime credit-default swaps sank to new record lows, while global corporate credit risk surged to a two-year high.
• Bear Stearns (NYSE:BSC) said on Tuesday that its two troubled hedge funds were essentially worthless following "unprecedented declines" in the subprime market.
• Dominion Bond Rating Service lowered the ratings of 94 residential mortgage-backed securities classes, citing increased delinquencies in underlying loans.
• Standard & Poor's lowered its ratings on 75 synthetic collateralized debt obligations and 32 European CDOs with links to subprime mortgages.
• The U.S. Treasury reported that foreign purchases of Treasuries declined in May to $21.6 billion, from $376 billion in April. China was a net seller for the second consecutive month. The agency separately said that the subprime market issues do not currently threaten the broader financial system.
• State-controlled Russian oil firm Rosneft postponed a planned dollar-denominated bond because of market volatility.
• Massachusetts-based power producer InterGen postponed a $1.975 10-year high-yield offering, originally scheduled for last week, and anticipated to now be sold today.

Companies issuing debt in the public markets included the following:

• Fannie Mae (NYSE:FNM) sold $2 billion in three-month bills and $1 billion in 30-year bonds;
• UBS sold $1.25 billion in two-year floating rate notes.

Hot tip
Homebuilder bonds recently overtook papermaker securities to win the dubiously coveted title of "riskiest junk bond issuers." Data from Morgan Stanley (NYSE:MS), as reported by Bloomberg, showed that in the 30 days ended July 6, the spread over Treasuries for homebuilder securities rose 1.07% to 4.53. That surpassed the 4.44% average spread for paper and forest-product makers.

The downgrade of subprime mortgage loans by Moody's and Standard & Poor's highlight concerns that the subprime sector's woes will spread to curtail the entire mortgage finance industry. This fear, in turn, is showing up in homebuilder debt, creating wider spreads. Credit ratings of firms such as Pulte Homes (NYSE:PHM) and Ryland Group (NYSE:RYL) are hovering just above junk level, where companies such as KB Home (NYSE:KBH) and Beazer Homes (NYSE:BZH) already reside.

Is it time to buy now? Some think the selling of homebuilders' bonds is overdone, citing favorable interest rates, falling home prices, and a strong economy. But a sound portfolio should not be constructed on such speculation. Homebuilders continue to post weak earnings and bleak outlooks. Even Fed Chief Bernanke chimed in last week and acknowledged that the housing market may weaken economic growth. Better to forego some higher yields and feather your nest with more conservative investments.

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. Fannie Mae is an Inside Value recommendation. The world is not enough for the Fool's disclosure policy.