Dr Worm/FA,
Time to buy TLT coming soon...Note the info from Jason Goepfert in the middle of the below article...
Fed Hawks Boost Yields
By JENNIFER ABLAN
THE BOND MARKETS were roiled last week as a Federal Reserve official indicated that the central bank could continue raising interest rates while inflationary pressures appear to be increasing in the U.S. economy and financial markets.
Dallas Fed President Richard Fisher sent Treasury yields sharply higher Thursday after he warned policy makers cannot "let the inflation virus infect the blood supply and poison the system." On Wednesday, Fisher, a voting member of the Fed's policy-setting Open Market Committee, also said inflation is at the "upper end" of the Fed's comfort zone. That marked a sharp reversal for Fisher, who rattled markets back in June after he said the Fed was in the "eighth inning" of its tightening cycle, implying a peak was near.
The yield on the benchmark 10-year Treasury note soared six basis points (hundredths of a percentage point) to 4.40% following his remarks on Thursday but settled the day at 4.39%. By Friday, buyers emerged in the wake of higher yields, sending the 10-year's yield down to 4.37%. But the key 10-year yield still ended up from 4.33% the previous week.
The yield on the two-year note, the Treasury coupon issue most sensitive to expectations about moves by the Fed, closed the week at 4.19%, up two basis points on the week, while the existing Treasury long bond, the 5 3/8s of Feb. 15, 2031, settled Friday at 4.57%, unchanged on the week.
The Dow Jones Industrials, meanwhile, were down about 2.62% on the week on Fisher's remarks that short-term interest rates were headed higher.
Investors were stunned by the strong degree of jawboning by Fed members in recent weeks. The week before last, Fed chief Alan Greenspan expressed his continuing concern about housing and financial imbalances.
Marc Seidner, director of domestic taxable fixed income at Standish Mellon Asset Management, says there are "trade-offs" in all the tough talk by Fed members on inflation and asset values. "They are sacrificing economic growth -- and the stock market is telling you that!"
What worries investors like Seidner most is that the Fed's rate hikes and warnings are coming at a time when energy prices are hitting consumers' wallets (for one example, see Review & Preview). In 11 consecutive meetings since June 2004, the Fed has raised the federal-funds rate target, taking it to 3¾% from 1%.
As such, Seidner has been buying the belly of the yield curve, five-year and 10-year Treasuries.
He's not alone in his view. Andy Brenner, head of global fixed-income trading and sales at Investec, has been telling clients to buy bonds. "The continual hawkish statements from the Fed continue," he says. "They were wrong about deflation, and they will be wrong with the magnitude of inflation."
That's a true contrarian stance, which is corroborated by the latest Commitment of Traders report on bond futures. According to Jason Goepfert of Sentimentrader.com., the preponderance of short speculative positions relative to longs among commercial hedgers (a.k.a. the "smart money') is among the biggest since October 1987. The mother of all bond rallies ensued after the stock market crashed that month.
There are signs of price pressures, nonetheless. Last week the Institute for Supply Management's manufacturing and services indexes, both for September, experienced huge jumps. In the factory survey, that index surged to 78 from 62.5 in August, while its nonmanufacturing prices index was 81.4, the highest since the index was launched in 1997, from 67.1 the month before.
Citigroup's chief U.S. economist, Robert DiClemente, observes that the Fed's work is changing to "preempting a more tangible inflation threat" from an unwinding of an unnecessarily accommodative stance. For that reason, he revised his forecast for short rates from a peak of 4% by year end to 4½% in early 2006. He says while a pause at 4% is still possible, there are "emerging risks" on the other side that the move may not stop until 5%. With Fed officials talking tough, the fed-funds futures market is pricing in two more 25-basis-point hikes by year end, to 4¼%.
Perhaps one less worry for investors is that Friday's employment report showed less hurricane-related restraint on payrolls than expected and "no evident weakening" in labor markets outside of the disaster's direct impact, says Peter Kretzmer, economist at Bank of America. Nonfarm payrolls fell only 35,000 in September, about one-fifth the job loss forecast by economists. (For more on last month's employment report, see Economic Beat.)
HUNTING FOR HIGHER YIELDS? Yes, it has been tough to find value in the fixed-income market. But there's one corner of the bond market that is offering income in the double-digits.
Last week billions of New York Stock Exchange-listed General Motors bonds with $25 par values hit fresh lows in price, but also produced yields over 10%. For instance, GM's 7.25% bonds (ticker: GMW), due April 15, 2041, fell to a 52-week low of $16.26 for a yield of 11.25%, while a similar issue, GM's 7.25% (XGM), due June 15, 2041, hit a new low of $16.20, producing a yield of about 11.30%. (Though these issues are listed as preferred stocks, they actually are debt securities.)
Even more compelling are GM's convertibles. It provides substantial downside protection, relative to the common stock, while offering a reasonable amount of upside potential if the giant auto maker eventually recovers from its many problems. The convertible 6.25s due 2033 (GPM) were trading around $19.19 for a yield-to-maturity of 8.422% and a yield-to-put in 2018 of about 9.40%.
All these securities are worth a look. Many have made round trips, from lows to higher prices and then back to fresh lows, since Barron's wrote about them last spring ("Preferred Vehicles," March 28). Compared with other low-rated debt securities, such as emerging-market bonds, GM preferreds look relatively enticing. Even Brazil, still a junk-rated credit, isn't offering yields of 10%, let alone 9%.
The Brazilian component of the J.P. Morgan Emerging Markets Bonds Index Plus has an average spread of around 350 basis points above Treasuries, with a yield of 7.97%. For the Russian component, the average spread is less than 100 basis points, with a yield below 5.50%.
Fitch Ratings recently cut GM's credit rating further into junk status -- to double-B from double-B-plus -- because it doesn't think the company is making significant progress in reducing its costs. The rating agency also cited "the incrementally negative effect" on sales of big sport-utility vehicles and other gas-guzzlers -- GM's core products -- from persistently high fuel prices. GM's woes have been deepened by the heightened financial risks associated with its relationship with Delphi, its key supplier, which was threatening to file for bankruptcy protection as this column went to press.
Yet GM and its financing arm, General Motor Acceptance Corp., have a combined $42 billion in cash and equivalents on their balance sheets, as well as tremendous access to the capital markets through securitization of auto loans. So they're hardly in an immediate bind.
To be sure, General Motors common shares, sporting a 7% yield, are vulnerable to a potential dividend reduction. But the preferreds "can be an interesting way for a retail investor to gain economic exposure to GM debt," says Tad Rivelle, the chief investment officer at Metropolitan West Asset Management.
One of the more attractive bargains is the GM convertible due in 2032 (GXM), offering a current yield of over 4.70%. But the issue has a put option, which lets the investor redeem it in March 2007. Its yield to the put is 8% -- more than double what most money-market funds pay.
For his part, Rivelle, like most institutional investors, is earning his 10% yield on GM by holding onto its institutional corporate bonds. The benchmark 8.375% senior debentures due 2033 were trading late last week around 78.25 (or $782.50 per $1,000 bond), for a yield of about 11%, according to KDP Investment Advisors. And, at 86.25, the 7.125% senior notes due 2013 yielded 9.68%.
"If one is willing is accept the notion that GM will eventually be viewed more favorably in the market, the investor has the prospect of high yields with the possibility of significant capital appreciation," he says. "Long GMs are trading at dollar prices in the low 80s, and hence, while there is some downside risk, we are disinclined to believe that -- in the near term -- GM [debt] would trade below its '$70 low.' Meanwhile, the investor gets to clip coupons."
Adds Rivelle: "I've always been amazed as to why investors have no fear when it comes to buying a large-cap, dividend-paying stock, yet shrink from owning the debt, which, of course, ranks above the stock in the capital structure."
AI
