Now that the Federal Reserve and Chairman Ben Bernanke have made it clear that they have no plans to change their monetary policy anytime soon, bond market participants can go back to what they lately seem to do best: worrying and chasing yield.
Even PIMCO bond king Bill Gross is getting into the act. A month before the Fed’s Wednesday announcement that it will keep stimulating the economy by leaving rates near zero and loading up the government’s balance sheet with more debt, the PIMCO Total Return Fund cut its Treasury holdings to 28% in February from 30% in January, according to Reuters.
The PIMCO Total Return Fund “showed an increase in exposure to high-yield ‘junk’ credit to 3% in February from 2%. That is the first increase in high-yield credit in four months,” reported the Reuters story, which also quoted Gross as acknowledging that both corporate credit and high-yield bonds “are somewhat exuberantly and irrationally priced.”
In addition to leaving the fed funds target rate unchanged at near zero—no surprise—the Federal Open Market Committee members said they would keep buying $85 billion of Treasuries and mortgage-backed securities every month “to support a stronger economic recovery.” While the FOMC’s goal is to achieve a sustained labor market recovery, the collateral damage from such a policy is single-digit yields even on higher-risk investments.
In other words, investors, get ready to keep on chasing yield for years to come.
“We continue to expect the Fed will maintain the current $85 billion per month purchase pace into next year, and will not start hiking interest rates until late 2015, at the earliest,” wrote Bank of America-Merrill Lynch Senior U.S. Economist Michael Hanson after the FOMC announcement. “The FOMC explicitly noted ‘more restrictive’ fiscal policy [from Congress] and continued downside risks, and nudged their growth and inflation projections lower.”
Opportunity in High-Quality Intermediate Bonds
But considering the current climate of frustratingly low yields in risky junk bonds and a moderately steep Treasury yield curve foreshadowing economic growth, where do the opportunities now lie for fixed-income investors?
In high-quality intermediate bonds, says LPL Financial Market Strategist Anthony Valeri.
“One of the brighter opportunities in the bond market for 2013, high-yield bonds, may be fading as the average yield of high-yield bonds declined to a new record low of 5.6% last week according to the Barclays Index data,” writes Valeri in “Ride the Yield Curve,” a March 19 bond market note. “In a low-yield world, bond investors have to look harder for investment opportunities, and riding the yield curve may provide an opportunity in high-quality bonds.”