Bond managers are sending mixed signals in response to the Fed's own signal that it is preparing to raise interest rates.
Money managers and pension fund executives are predicting the Federal Reserve Board will raise interest rates at its meeting at the end of this month. Many believe the Fed will tack on 25 basis points to the overnight lending rate.
The move provides investors with a variety of opportunities.
The San Francisco City & County Employees' Retirement System since March has been adding steadily to its cash position in its domestic bond portfolio because of the threat of inflation, said Dick Piket, senior investment officer, fixed income, who manages the $910 million portfolio comprising mortgages and Treasuries.
Payden & Rygel, Los Angeles, sees the potential rise in interest rates as a buying opportunity in corporate high-yield bonds, mortgage-backed securities and emerging market debt, said Brett Wander, vice president and senior portfolio strategist.
And BlackRock Inc., New York, moved its bond portfolios back to market neutral last week when the 10-year Treasury bond hit 6%, said Keith Anderson, chief investment officer, fixed income.
Chairman Alan Greenspan's Fed has been holding interests rates steady since last year, after he chopped them three times last fall. Now, as investors fear inflation due to a strong domestic economy, a recovering global economy and an overheated U.S. stock market, the impending interest rate rise has caused shifts in bond portfolios.
In fact, bond markets have been bearish through 1999, but not all investors think the Fed will cut rates.
"It's 50-50 at best," said Mike Millhouse, executive vice president and CIO at Loomis, Sayles & Co. LP. "I don't feel the Fed needs to raise rates. Greenspan has talked the market into a rate increase already."
Interest rates on the 30-year long bond have risen steadily to 6% by the middle of last week after starting the year at 5.3%, said Allen Webb, fixed-income analyst with the $24.2 billion Retirement Systems of Alabama, Montgomery.
This year, Alabama, which runs its investing program in-house, has spent between $400 million and $500 million on government agency issues and A rated corporate bonds, he said. Funding has come from cash flow. That spending is less than usual, he added.
"We lucked out," he said. The fund "has maintained a low cash position. It spent more money on equities and fixed income at the end of last year."
Historically, the fund has run between 5.5% and 6% cash, he said. At the moment, its position is 3.5%.
The $10.2 billion San Francisco system, however, has increased its cash position to 6% from 2% in March in a domestic portfolio that holds only government and mortgage-backed securities, Mr. Piket said. "Increasing the cash position is unusual for me," he said, adding the threat of inflation is evident in stock prices. The Federal Reserve will make cuts "because of financial asset inflation."
And San Francisco will "leave (that money) in cash until the market is a better value," Mr. Piket said, adding the goal will be "getting the portfolio's duration neutral rather than short."
The portfolio's benchmark is a customized version of the Lehman Brothers Aggregate bond index.
Some investors are buying corporates.
In the past few weeks, Payden & Rygel has moved to 10% overweight from close to neutral in mortgages and corporate bonds, Mr. Wander said. He declined to name specific corporate issues, but said he had recently purchased media and telecommunications company bonds.
At the moment, those corporates are between 140 and 150 basis points over the 10-year Treasury bond, he said. The yield spread "will either tighten or not widen much more. In either case, there is a significant yield advantage."
Some investors are focusing on government agency issues. BlackRock bought 10-year commercial mortgage-backed securities and 30-year discount mortgage pass-throughs such as Fannie Maes and Freddie Macs when interest rates hit 6% last week, Mr. Anderson said. The manager, with $35 billion in institutional, fixed-income assets, had been slightly short its duration, he said.
Mr. Millhouse, with Loomis Sayles' core bond group in Chicago that has close to $18 billion in pension fund and endowment money under management, also said Fannie Mae and Freddie Macs present a good buying opportunity.
"We're seeing opportunities in different areas where we didn't see them a few weeks ago," he said. With 10-year Treasuries at 6%, the 60 basis point spread of Fannie Maes was attractive, Mr. Millhouse said. He also pointed to BBB corporate bonds in the energy and gas sectors as buys.