For the third straight time, the Federal Reserve chose to leave interest rates steady, yet that wasn't good enough to woo investors into Treasuries.
Investors still prefer higher-yielding bonds such as corporate and asset-backed debt. And some are convinced that the Fed will boost rates by yearend, prompting a decline in Treasury securities.
The Fed held its target for the federal funds rate, the rate banks charge each other for overnight loans, at 5.5% because prices aren't rising too fast, even as the economy chugs along. Though that ought to be good for Treasury bonds, because inflation eats away at the value of fixed-income investments, investors didn't buy. Despite the good news, investors were concerned that the economy is picking up speed.
"We're not going to look at anything in Treasuries until the bond hits 7%," about half a percentage point higher than it is now, said Denny Niedringhaus, who manages about $300 million for Southwest Ban
k of St. Louis. "Whether or not there's any inflation, we think the mere fact that the economy remains strong can push yields back up."
The benchmark U.S. 30-year bond barely budged after the Fed announced its decision, which was widely expected by traders and investors. The benchmark 30-year bond climbed $1.88 per $1,000, to about 98.28125, nudging its yield down 1 basis point, to 6.51%.
Mr. Niedringhaus said he's got a chunk of his holdings in short-term debt of ultra-safe government-sponsored enterprises, which carry the highest ratings yet offer a little more yield than Treasury bonds. That extra yield, however small, is important for investors looking to boost returns at a time when bond prices aren't expected to rise.
"We're waiting to invest at better levels (in Treasuries), making the assumption rates are going to be higher later" and prices lower, Mr. Niedringhaus said. He said he would then consider buying Treasuries of intermediate maturities, such as seven-year notes.
Alex Vallecillo, who helps manage about $11 billion in bonds for National City Asset Management in Cleveland, agrees. He favors higher-yield debt of corporations, which are likely to benefit from continued strength in the economy. Also on his list are bonds backed by car and home equity loans.
These so-called asset-backed bonds "give you some of the characteristics of mortgage and corporate bonds without as much risk," said Mr. Vallecillo. He said he sees yields on 30-year government bonds staying between 6.35% and 6.85% in the months ahead.
Ben Mayer, manager of $1.3 billion in bonds at AMR Investments in Fort Worth, said he expects bond yields to rise to about 6.75% by the end of the year, as the economy speeds up and investors become more concerned about inflation. He said the Fed still could raise rates at meetings in September or November.
Mr. Mayer said he bought floating-rate corporate bonds with coupons pegged to the U.S. two-year note, on expectation that shorter-term Treasuries will suffer the most from any Fed rate increase.
Higher yields would sweeten the interest payments he gets on his floating-rate debt, when the coupons are reset.
The central bank last raised the overnight bank lending rate in March by a quarter point.
Mr. Mayer is also among those investors who predict yields on longer- term debt will eventually fall after a Fed rate increase designed to keep prices from rising too quickly, because these securities are the most vulnerable to inflation.
"The long end would be able to see through (a rate increase) and at some point head back toward 6%" because the higher rates will help stamp out inflation, Mr. Mayer said. "The longer end benefits from the low-inflation environment."
Even so, some investors remain concerned that the strongest job market in a generation will accelerate wage increases and spur inflation. Some traders pointed to last week's settlement between the International Brotherhood of Teamsters and United Parcel Service of America Inc., which gave the union most of what it demanded.
"It appears the teamsters got a lot of what they were looking for," Mr. Niedringhaus said. "People are thinking companies will start to give in on the wage front, and that could lead to wage pressure."
That could result in at least one more Fed rate increase this year and drive government bond prices lower, making the yields offered by corporate bonds and other so-called spread products that much more attractive, traders said.
"I feel that clipping coupons is still a good strategy," Mr. Vallecillo at National City said.
