Buyers jump into corporate and muni bonds after Fed move

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The Federal Reserve’s move to zero on its benchmark short-term interest rate on Tuesday was the equivalent of trying to dynamite the credit crunch, to reopen routes for money to flow.

It’s definitely having that effect: Some investors are rushing into parts of the credit markets where they wouldn’t venture even a week ago.

‘The process by which investors seek alternatives to cash has begun ... prodding investors to move out the risk spectrum’ in search of higher yields, said Tony Crescenzi, bond market strategist at Miller, Tabak & Co. in New York.

That is showing up in heavy buying of exchange-traded corporate bond funds, for example.

The share price of the iShares iBoxx Investment Grade Corporate Bond Fund (ticker symbol: LQD), an ETF that holds $6.2 billion of high-quality corporate debt, jumped $2.37, or 2.4%, to $100.22 on Thursday. The fund is up 6.1% in the last three sessions, after rising 2.8% for all of November.

In the junk bond sector, shares of the SPDR Barclays Capital High Yield Bond ETF (ticker: JNK) rose $1.11, or nearly 4%, to $29 on Thursday. The fund is up 7.4% from its low set a week ago.

Yields on junk securities remain sky-high, but have pulled back a bit as the bonds’ prices have rallied. The average yield on an index of 100 junk bonds tracked by KDP Investment Advisors was 16.49% on Thursday, down from 17.12% on Wednesday and down from an 18-year high of 17.70% a week ago.

Treasury bond yields also continue to slide, after the Fed said that the sinking economy was ‘likely to warrant exceptionally low levels [of short-term rates] for some time.’ The central bank also said it might buy Treasuries for its own portfolio, to keep downward pressure on longer-term interest rates.

For now, the Fed’s jawboning seems to be enough: The 10-year T-note yield dropped to a new generational low of 2.07% Thursday from 2.19% on Wednesday and 2.57% a week ago.

But it’s the pullback in corporate bond yields that will encourage the central bank, with the economy still starved for credit.

The question is whether the buyers of corporate bonds this week are investors looking to lock in yields, or just speculators chasing a short-term momentum trade. With the economy still sinking, you’ve got to have guts -- and real patience -- to be taking more risk in the bond market, particularly in junk securities.

Some investors who are hunting for yield are rightly focusing on tax-free municipal bonds rather than taxable corporate issues, with muni yields still historically high.

The tax-free yield on a Bond Buyer index of 40 long-term muni bonds was at 6.16%, on Thursday, down from 6.60% on Monday, as buyers have jumped back into the market.

‘Munis are where so much of retail fixed-income money has gone’ recently, said Kevin Giddis, head of fixed-income sales at brokerage Morgan Keegan Inc. in Memphis.

But the muni market, too, is heading for a bumpy ride in 2009, as state and local finances continue to deteriorate (just look at California’s budget mess).

Bond yields are tempting, but like I said -- any investor moving into the market now had better have guts and patience.

-- Tom Petruno