Fed’s ‘Operation Twist’ Offers Bond Investment Opportunities

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.