After Slide, Yields May Find Footing

Time for investors to lock in longer-term interest rates?

Yields on Treasury securities plunged Friday, after a downbeat May employment report bolstered expectations that the Federal Reserve is nearing the end of its two-year string of interest rate hikes.

That could be good news for borrowers, who have seen rates on mortgages and other loans rise sharply since mid-2004.

It also could be a signal for investors and savers who benefit from higher interest payments on bonds, savings certificates and other fixed-income securities to grab the best returns they can find, if they fear that rates have peaked.

But some financial professionals were advising caution Friday, noting that over the last year Wall Street often believed that interest rates had topped out, only to see them rise further.

“My gut tells me that the 10-year [T-note] yield is going to go up again,” said Joseph LaVorgna, fixed-income economist at Deutsche Bank Securities in New York. He expects the yield to hit 5.5% by year’s end, given continuing worries about inflation and rising rates abroad.

Investors, he said, would be better off keeping their savings in short-term accounts for now. The average yield on money market mutual funds, for example, is 4.4%, according to IMoneyNet of Westborough, Mass. The yield on six-month T-bills is 5%.

Tony Crescenzi, bond market strategist at brokerage Miller Tabak & Co. in New York, said he was surprised by how aggressively investors snapped up longer-term bonds after the employment data were reported.

The yield on the 10-year Treasury note, a benchmark for mortgages, tumbled to a six-week low of 4.99% from 5.1% on Thursday. The two-year T-note yield slid to 4.91% from 5.02%.

Bond yields fall as the prices of the securities rise.

Crescenzi noted that, at 4.99%, the 10-year T-note yield was below the Fed’s key short-term rate of 5%.

Normally, yields on longer-term securities are higher than yields on short-term securities to compensate investors for the risk of tying up their money.

Historically, investors have pushed the 10-year T-note yield below the Fed’s rate “only when there’s the utmost confidence that the economy will slow,” eventually leading to lower rates across the board, Crescenzi said.

But some analysts said technical factors might have helped stoke the rally in bonds Friday. Traders who had previously “shorted” bonds -- meaning they borrowed the securities and sold them, betting that prices would drop -- may have been rushing to close out their bets as prices rose instead, said Tom Atteberry, a bond fund manager at First Pacific Advisors in Los Angeles.

As short sellers buy bonds to return loaned securities, they temporarily help drive prices up and yields down.

Atteberry is among the investors who believe that, even though the economy is slowing, there is no reason to feel an urgent need to lock in longer-term yields.

For one thing, he said, even if the Federal Reserve was finished tightening credit, “it doesn’t mean they’re going to go the other way” and cut rates. If the market expects policymakers to just hold their rate at 5% for an extended period, longer-term yields, such as on Treasury notes, might not decline much more, Atteberry said.

In addition, bond pros note that long-term interest rates are affected by conditions beyond the level of short-term rates. More so than with short-term securities, inflation is a big factor in determining what investors expect to earn on longer-term securities, because it erodes fixed-rate returns on bonds.

Rising inflation pressures, partly from high energy prices, had helped to drive the 10-year T-note yield to a four-year high of 5.2% on May 12.

Many investors remain concerned that inflation could continue to rise, which could limit how low longer-term bond yields would go even if the Fed was done tightening credit, Atteberry and other analysts said.

Another concern is that longer-term interest rates in Europe, Japan and elsewhere have been rising this year as the global economy has expanded. That could put more upward pressure on U.S. yields as well because the U.S. competes for capital with other nations, LaVorgna said.

Still, Crescenzi said, investors who are nervous about missing a peak in interest rates might want to start “nibbling” at longer-term yields by shifting some savings into two-year or three-year T-notes or other securities with those maturities.

Experts often suggest that investors “ladder” their fixed-income portfolios, always holding securities of various maturities rather than owning only short-term or long-term accounts.