The bond market couldn't hold a candle to the stock market in the first quarter, but bonds' performance may have been just fine for investors who figure the far greater risk today is getting burned in red-hot equities.
U.S. bond mutual funds' first-quarter total returns, which count principal change plus interest income, will be in the 0.8% to 1.3% range for most types of funds, according to preliminary data from fund-tracker Morningstar Inc.
That reflects what ended up being flat to slightly higher long-term yields as of Monday compared with year-end levels.
The yield on the bellwether 30-year U.S. Treasury bond, for example, ended Monday at 5.97%, up from 5.92% on Dec. 31.
So most investors in long-term Treasury issues garnered their return solely from interest income on the bonds, with a slight loss in principal value as market yields edged up.
Yields on shorter-term U.S. securities ended the quarter lower, with the one-year Treasury note at 5.43%, down from 5.55% on Dec. 31.
Yields had tumbled to their lowest in more than two decades in mid-January as the Asian economic crisis took a turn for the worse. Talk of global depression helped spur investors to lock in yields.
The 30-year T-bond yield fell to 5.66% in mid-January, the lowest since the Treasury began regular auctions of 30-year securities in 1977, amid expectations the economy would slow.
But as the quarter wore on, the U.S. economy's strength appeared to largely offset Asia's negative effect, pushing U.S. interest rates up again. By early March, the 30-year T-bond yield had climbed as high as 6.07%, before drifting lower in recent weeks.
"We have this pitched battle between the effects of Asia and the current strength of the economy," said Jim Midanek, who oversees $3 billion at Turner Investment Partners in Walnut Creek, Calif.
Still, with inflation continuing to decline worldwide, the overall trend in yields in Europe, Japan and the United States was flat to downward in the quarter.
That was the case even as the corporate sector issued new bonds at a blistering pace, in many cases refinancing older, higher-yielding securities at lower rates.
The average high-yield corporate junk bond fund gained 3.6% in the quarter, according to Morningstar, as investors clamored for better yields.
Investors are "comfortable about buying bonds," said Eric Cheung, who manages $2.8 billion of bonds at Wilmington Trust Corp. in Wilmington, Del. "Worldwide, inflation is not an issue anymore."
Inflation--the bond market's biggest enemy because it erodes the value of fixed-income securities--is running at about 1.4% in the United States and is below 2% in much of Europe and Japan. At the same time, the U.S., Britain, Canada and other nations expect to balance their budgets in the next few years, resulting in lower government borrowing.
Bonds had a better quarter in Europe as yields fell sharply in many countries, in part because of optimism about interest-rate convergence as major European countries move toward monetary union next Jan. 1.
The total return of the average international bond fund tracked by Morningstar was 2.4% in the quarter.
Many analysts continue to be optimistic about prospects for lower bond yields in Europe.
Bonds may rally further in countries such as Italy, which may need to cut interest rates in preparation for entry into the European monetary union, experts said.
"Italian bond [prices] are destined to rise on hopes of imminent rate cuts," said Andrea Mottarelli, who helps manage some $1.7 billion in bonds at Gestioni Fondi Investimento Milano.
Italy's benchmark short-term discount rate now stands at 5.5%, compared with Germany's benchmark of 3.3%. EMU member countries will be governed by a single benchmark beginning next year.
German yields, already hovering near record lows, are likely to decline with no inflation danger ahead and little risk the German central bank, the Bundesbank, will raise interest rates soon.
"The trend of falling yields is intact," said Bernd Karstedt, who helps manage $27.5 billion at Union Investment in Frankfurt.
In Japan, meanwhile, yields on long-term government bonds are below 2%, a reflection of that economy's dismal prospects.
But can the long slide in interest rates--which now has gone on for most of the 1990s--continue indefinitely?
Some analysts warn that if the global economy quickly shakes off Asia's woes--and/or if inflation begins to tick higher--the surprise could be that central banks will be forced to tighten credit. That could quickly send bond yields spiking higher again.
Given that worry, some portfolio managers say the best bond bets may be in the developed country where yields are highest--the United States.
"From a global standpoint the U.S. bond is a bargain," said Jack Ablin, who helps manage about $7 billion at Barnett Capital Advisors Inc. in Jacksonville, Fla.
The yield on the 10-year U.S. Treasury note, at 5.71% now, is well above the 4.93% yield on 10-year German government bonds and the 5.13% yield on 10-year Italian government bonds, to name but two alternatives.
"I'm still bullish" on the U.S. market, said David Berry, who oversees $27 billion of fixed-income securities at Lincoln National Corp. in Fort Wayne, Ind.
A Bloomberg News survey of economists, bond strategists and traders at Wall Street's 37 primary government bond dealers found that none expect the Federal Reserve Board to move short-term interest rates at today's meeting.
The Fed last raised interest rates in March 1997, when it boosted its benchmark federal funds rate to 5.5% from 5.25%.
Bloomberg News was used in compiling this report.
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How Low Can They Go?
Long-term U.S. bond yields are ending the quarter flat or slightly above their year-end levels, but yields in Europe and Japan have continued to slide. A sampling of yields on 10-year government bonds, by country, monthly closes and latest:
Source: Bloomberg News