Treasuries, Other Taxable Bonds, Munis Rose In Q2

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Like Goldilocks tasting the little bear's porridge, fixed-income investors in the second quarter found the economic news not too hot, not too cold, but just right!

As a result, investors were as hungry for risk as Goldilocks was for porridge.

The riskier a taxable category was, the better it did. Hard-currency emerging markets debt funds led the way, soaring 0.77% in June and 4.74% in Q2, according to preliminary data from Lipper Inc.

BBB-rated corporate funds rose 0.30% in June and 2.94% in Q2. High-yield funds gained 0.79% and 2.11% in the month and quarter.

Treasury funds gained 2.59% in Q2 despite losing 0.23% in June.

Treasuries had a tough June due to the improved economic outlook. Investors increasingly felt comfortable putting their money to work elsewhere, including stocks.

"Some economic indicators are starting to turn up," said Rick Raczkowski, co-manager of $1.8 billion Loomis Sayles Core Plus Bond Fund . "We're seeing healing in labor markets, increased loan demand, increased loan availability, stronger industrial production and business confidence. We could see better housing growth in the second half, especially with the decline in mortgage rates."

Flatter Curve

The yield curve flattened slightly in the quarter as the yield on two-year notes edged up 3 basis points to 0.469% while the yield on 10-year notes fell 20 basis points to 2.53%.

"That reflected market perception of the Federal Reserve's thinking," Raczkowski said. The economy is growing slowly enough that investors did not expect a change in pace of the tapering in the Fed's bond buys. Nor did they expect the Fed to speed up the timetable for raising rates.

Investor buys of longer Treasuries pushed prices up and the yield down.

Raczkowski expects a better economy in the second half. And he does not see inflation rising above the Fed's 2% target.

"The macro environment will continue to be supportive of the bond market, especially non-Treasury spread products," he said.

The warming economy is cooling his interest in high-quality investment-grade bonds in some defensive sectors like food and consumer staples.

During Q2 he owned a bond from Brazil's Braskem, the largest producer of resins in the Americas.

The bond, which matures July 22, 2041, has a 7.125% coupon and is rated Baa3 by Moody's.

Its Q2 total return was 9.02% as its yield slipped to 6.89% from 7.48% at the quarter's start. The comparable Treasury returned 4.68%.

It benefited from investor sentiment in favor of emerging markets and strong company fundamentals. It also reflected outperformance in the 30-year part of the curve.

Munis

Tax-exempts posted gains for Q2 despite suffering setbacks in June in almost every category.

One reason was low new issuance. Peter Hayes, head of the municipal bonds group at BlackRock, says Q2 issuance left munis 17% below the average pace for the first six months.

Also, munis often track Treasuries. Treasury prices downtrended from late May through June.

Muni prices should get a boost this month. Issuance is not scheduled to rise, and many investors will reinvest summer coupons.

The key economic indicator that muni investors will be watching is the jobs report, Hayes said. "If we get 225,000 (new jobs per month) or higher, the market might view economic growth as sustainable and we might see a backup (rise) in rates," he said.

The Detroit bankruptcy is not affecting the broader market, he said.

But he's concerned about Puerto Rico, whose bonds have sold off. "That tells us something is going on," he said. Puerto Rico bonds are widely held, and unlike Detroit debt, the worst case scenario has not been priced into the Commonwealth's bonds, Hayes said.

Hayes owned a University of Illinois bond issued to finance capital improvements at the Urbana-Champaign campus.

The bond, with a 5% coupon, matures April 1, 2044, and has a call on April 1, 2024, at par. They're rated AA- by S&P.

Its Q2 return was 3.28% as its price to call rose to 108.424 from 104.977. The Barclays muni index gained 2.59%.

The bond benefited from a steepening of the yield curve at the long end, 20 years and longer, Hayes said.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Mutual Funds

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