Outflows Clobbered Treasuries In July; Munis Down Too

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The investor stampede out of long Treasuries that began in May, and in June for other types of rate-sensitive bond funds, continued in July.

Exhibit A: Treasury funds fell 0.69% last month, according to preliminary Lipper Inc. data.

Shareholders yanked $44 billion from taxable funds in June, says the ICI. They pulled out an additional estimated $19 billion last month, according to TrimTabs.

As a result, bond fund categories seen as the most vulnerable to interest rates were down in July. The least sensitive groups were up.

Treasury funds led decliners down. But high-yield funds gained 1.87%. Foreign debt funds tacked on 1.19%. Loan participation funds added 1.08%.

The rush out of taxables was fueled by Federal Reserve Chairman Ben Bernanke's hints of earlier-than-expected tapering of the Fed's bond buying. It was also fed by concerns over Japan's volatility and slower growth in China.

Bargain Hunters

To ease investor worries, Fed officials emphasized at the end of June that they were not close to tapering.

Figuring that the least rate-sensitive taxables had been oversold, investors began to hunt for bargains in July, said Mark Lindbloom, manager of $10 billion Western Asset Core Plus Bond Fund .

High yield, investment grade corporates, emerging markets, nonagency mortgage and commercial mortgage-backed securities rallied in July. "Investors are still looking for yield," Lindbloom said.

The yield curve steepened as the yield on two-year notes dropped 5 basis points while the yield on 10-year Treasuries rose 8 basis points. The yield on 30-year Treasuries jumped 12 basis points.

"There was heavy selling at the long end, driving prices down, due to rate fears," Lindbloom said.

Lindbloom expects late July to be the model for taxables through the summer. That should benefit spread sectors, the same categories that rallied as the Fed calmed investor fears of early tapering.

But if key indicators, such as jobs gains, show stronger-than-expected economic growth, investors will again bail out from many taxables. "Investors will fear an earlier start to Fed tapering," he said.

Lindbloom owned a 10-year subordinated Wells Fargo bond rated BBB by Fitch, which typified the late July rebound in spread products. Its coupon is 5.57%. At the low point of the June sell-off, its price was 95.25. By the end of July it was 97.75, for a total return of 0.08% in July, 3.18% from June 24.

Motown Morass

Rate concerns and Detroit's bankruptcy filing hit tax-exempts. Michigan bond funds lost 1.64% on average in July, trailing only Massachusetts and New York among single-state funds. Moody's downgraded several Michigan issuers in July.

Even with maturities and bond calls shrinking the supply of munis, demand lagged supply, said Ted Jaeckel, co-head of BlackRock's muni desk. Tax exempts overall lost 1.05% on average last month.

Tax exempts will stabilize when retail muni investors join taxable investors in buying munis for their high-yield ratios vs. taxables.

"In many cases you're getting the tax exemption for free," Jaeckel said.

Last month he owned a 30-year Houston airport system senior-lien revenue bond, rated AA- by S&P. It is due July 1, 2039, callable July 1, 2018. The bonds are secured by various airport fees. Its July total return was -1.1% vs. -2.46% for the Barclays 22+ Municipal Bond Index.

The call option cuts the bond's sensitivity to interest rate fluctuations, which explains its July outperformance, Jaeckel said.

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

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

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