Investors eye higher bond yields

New York: Recession or not, the hunt for yield is on.

Investments in riskier bonds are picking up speed now that the worst year on record is in the rear-view mirror. Federal efforts to buoy financial markets and close to record high yields are emboldening investors in the face of a deepening economic slump.

"There are a lot of folks doing the math and asking 'What would have to happen for this investment to be bad? The world would have to be horrific'," said Jason Brady, a money manager at Santa Fe, New Mexico-based Thornburg Investment Management.

Money flows into high-quality mortgage and corporate bonds increased last week, with junk-rated company debt drawing cash for a sixth straight period, according to AMG Data Services.

Investors have concluded that it's finally safe to wander from the safety of US government debt, which hit record low yields in December and still hang below one per cent for two-year maturities.

The pledge by the government to support key pillars of the bond market with purchases or guarantees has eased the fears that kept investors from considering yields that would compensate them even under catastrophic default conditions.

Corporate and mortgage bond yield premiums have dropped since November as managers began to shift into riskier assets. That followed federal proposals to flood financial markets with cash and increase the backstop to private financial markets with its guarantee.

Even so, managers can still get yields on investment-grade corporate debt near eight per cent, and more than three per cent on the mortgage securities backed by government-controlled Fannie Mae, Freddie Mac and Ginnie Mae.

Meanwhile, 10-year US Treasury notes yield 2.4 per cent.

Higher yields and a push into the debt by new investors, including traditional stock owners, are providing juice, according to analysts at JPMorgan Chase.

Two-thirds of investors surveyed by JPMorgan reported a bullish outlook on yield spreads for the coming month, the most since the investment bank began its poll in 2001. Half of the managers expect high-grade bond assets to rise this quarter.

A survey by Stone & McCarthy Research Associates found portfolio managers have 73.6 per cent of assets in bonds other than Treasuries, the highest reading since 2003.

To be sure, forecasts for rising corporate and consumer defaults will curb the enthusiasm, according to JPMorgan. The risks of disappointing corporate earnings are palpable, while economic data points to a deepening recession.

The Labour Department on Friday reported that the US unemployment rate surged more than expected last month to 7.2 percent, the highest in 16 years.

"Nobody is looking for the economy to do better probably until the second half of the year, but the financial markets, just as they were ahead on the downside, tend to be ahead on the upside," said Don Galante, senior vice-president of fixed income at MF Global in New York.

After their worst year on record, junk bonds have rallied sharply since the Fed cut interest rates to as low as zero last month, encouraging investors to shift into risky assets in search of yield.

The bonds have posted nearly a 7.5 per cent gain in total return in December and rose another 5.7 per cent in the first eight days of the new year alone, according to Merrill Lynch.

US Treasury securities have lost 1.07 per cent so far this year.

Another sign of demand for riskier debt: narrower risk premiums. Investment-grade corporate bond spreads have narrowed by 89 basis points since hitting a record 656 basis points over Treasuries on December 5, according to Merrill Lynch data.

Junk bond spreads have narrowed by 515 basis points from their December 15 record high of 2,182 basis points over Treasuries.

A Cablevision Systems unit on Thursday sold the first junk bond new issue of 2009, attracting enough demand to increase its size by 69 per cent to $844 million.