Even though stocks dropped immediately after the Federal Reserve’s “Operation Twist” announcement on Wednesday, analysts said the Fed’s move means investment opportunities in the world of fixed income, both in corporate bonds and Treasuries themselves.
Investment strategists say the Federal Reserve policymakers’ announced goal of bending the Treasury yield curve in order to keep interest rates low and encourage growth opens up some new possibilities, even if it does look like the Federal Open Market Committee (FOMC) has run out of options in its monetary-policy toolbox.
In its Operation Twist announcement, the FOMC specified that by the end of June 2012, the Fed intends to purchase $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. The Fed also will now reinvest principal payments from its holdings of agency debt and mortgage-backed securities back into agency mortgage-backed securities.
What does this easy-monetary policy move mean for bond investors? Here’s a roundup of what the strategists are saying:
Doug Roberts, chief investment strategist for ChannelCapitalResearch.com, Shrewsbury, N.J.: “The fear of holding any risky assets…has resulted in a flow of funds into Treasury securities. The supply of U.S. dollars is controlled by the Federal Reserve, which can print U.S. dollars at will to satisfy its debt obligations and maintain low interest rates. The value of the U.S. dollar might suffer considerably, and there could be substantial inflation. This may be linked to the current rise in gold prices.
For those who claim that such a scenario could never occur, one must remember that during World War II, the United States was able to maintain very low interest rates during a time of severe inflation. However, there were substantial restrictions on trade and commerce. Owning gold was also prohibited. U.S. Treasury bonds may also remain attractive when compared with other alternatives. To borrow from Winston Churchill, “Treasury bonds may be the worst investment except for everything else.”
Anthony Valeri, fixed-income strategist for LPL Financial, San Diego: Operation Twist is not just an exercise to reduce Treasury yields but also an attempt to motivate investors to buy corporate bonds and mortgage-backed securities. By purchasing additional intermediate- and long-term Treasuries, the Fed hopes to reduce the outstanding stock of Treasuries. Reducing supply of such Treasuries would exert pressure on investors to consider other intermediate- and long-term bond options such as corporate bonds and MBS.
Even if Treasury yields do not budge, the Fed could indirectly lower borrowing costs for corporations and residential homeowners/buyers and stimulate the economy by pushing investors into these sectors. At a minimum, the Fed would likely consider Operation Twist a success if it managed to reverse some of the yield spread widening of the past few months. Corporate bonds have actually decreased in price over the past month despite Treasury strength.
Chris Shayne, senior market strategist, BondDesk Group, New York: Given that Treasury and high quality corporate yields are near their lows for the past 50 years, we feel that investors looking for relative value in fixed income should consider purchasing lower rated investment grade corporate bonds. Since the economic troubles started in late July, the yield patterns have all changed considerably.
Spreads over Treasury have uniformly increased for all rating grades except AAA. Spreads for A bonds have widened the most, followed by BBB, and then AA, but the absolute level of yields is still highest for BBBs because they started at a higher point. Yields of top quality investment grade firms, AAA and AA, have fallen along with Treasury yields. However, yields of lower quality IG firms, A and BBB, have risen substantially, exposing a unique buying opportunity for investors in corporate bonds. Investors looking for fixed-income exposure should consider A and BBB corporate bonds to capitalize on the wide spreads and lock in returns.