Treasuries Up In Jan.; Emerging Markets' Debt Sank

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Bond investors are still jumpy about Federal Reserve tapering and the prospect of interest rate hikes.

Last May and June, they took out their jitters on Treasury bonds and funds.

In January, funds with credit risk got hit as investors fled to bonds with greater perceived safety.


Emerging markets' local currency funds plunged 4.37% on average, based on preliminary Lipper Inc. data. Emerging markets' hard currency funds slid 1.58%.

In contrast, Treasury funds soared 3.29%. Corporate bond funds rated A gained 1.89%. GNMA funds rose 1.72%.

"The problem is this whole story surrounding emerging markets," said Matthew Pallai, co-manager of $1.7 billion JPMorgan Multi-Sector Income Fund . "Investors think risk may be overpriced."

Emerging market angst is fueled by concern over China. As GDP growth slows, investor anxiety is mounting about liquidity and solvency crunches hurting the Middle Kingdom's shadow banking system -- basically a replay of the U.S. financial crisis.

And investors are wondering whether emerging markets will be able to buy as much from developed markets.

"That's weighing on developed markets' equities and high yield," Pallai said.

High-yield bonds gained a relatively modest 0.51% last month. High yield's 6.82% gain in 2013 led all taxable bond-fund categories.

As the Fed extended its bond-buy tapering on Jan. 29, investors flocked into short-term bonds and funds. Prices rose faster on the short end of the yield curve, flattening the curve last month.

The yield on two-year notes fell 39 basis points to 3.40%. The yield on 10-year notes fell 37 points to 2.67%.

Outlook

Pallai likes credit over duration risk in part because he expects U.S. GDP growth to continue.

"We still like high yield, credit in Europe, financials in Europe, especially down in the capital structure, and some securitized debt like CMBSs (collateralized mortgage-backed securities)," he said. "Even though they've tightened (meaning that their prices have declined relative to Treasuries), we still like nonagency mortgages too."

The pullback in emerging markets is close to making valuations attractive enough to start buying, he adds.

Pallai held a Royal Bank of Scotland ( RBS ) 6% coupon bond, maturing Dec. 19, 2023, rated BB+ by S&P to take advantage of strengthening fundamentals among European financials and for its yield, which fell 5 basis points to 5.85% last month, for a total return of 0.86%.

Munis' Moves

Tax-exempt funds had a strong January, rising overall 1.87%. Investors sought refuge in them as they fled sectors such as emerging markets. Also, supply was thin while demand spiked as investors looked to reinvest quarterly coupons.

Lyle Fitterer, lead manager of $2.7 billion Wells Fargo Advantage Muni Bond , says new supply projections for all of 2014 are low.

"If supply picks up, munis will perform more in line with (Treasury) rates," he said.

Detroit's bankruptcy and Puerto Rico's woes have not infected the rest of the bond market much, he adds.

Fitterer likes munis' outlook. "It's still one of the cheapest segments out there, especially in view of taxes going up," he said.

He owned a Chicago general obligation bond with a 5% coupon, maturing in 2034. Its price rose to 100.04 from 94.79 last month, for a 5.95% January return. "That illustrated the demand for income in the muni market," he said. It also showed investor approval of Illinois' new pension change.



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

Referenced Stocks: RBS

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