Mood shift on Wall Street: Investors are taking risks again

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Sometimes, rising interest rates can be good news. That’s the case with the sudden reversal in yields on U.S. Treasury securities in recent weeks.

Even as Treasury yields have moved back up, yields on other bonds have fallen. And the stock market has continued to rally, lifting key indexes to two-month highs.

All of this suggests that some investors are selling Treasuries to buy other securities. It’s a sign that the fear that had been gripping markets since September -- driving many investors into Treasuries as a haven -- is continuing to ease.

The 10-year Treasury note yield, which fell to a record low of 2.06% on Dec. 30, has rebounded to 2.47%. The 30-year T-bond yield, which was 2.52% on Dec. 18, has jumped back to 3% since then.

On the face of it, this is bad for Uncle Sam and for taxpayers: With Treasury borrowing at record levels to fund the economic and financial bailouts, any increase in yields means a bigger interest bill for the government.

President-elect Barack Obama warned Tuesday that ‘Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery we are working on.’ Indeed, Treasury yields may be rising in part on concern about the huge supply of bonds coming to market.

But a major goal of the government’s bailout efforts is to restore investors’ willingness to take risks, which should translate into lower borrowing costs for companies, local governments and consumers.

‘The whole idea is to get long-end rates down,’ said Alex Li, interest rate strategist at Credit Suisse in New York.

So far, it’s working:

--- Yields on mortgage-backed bonds issued by Fannie Mae and Freddie Mac sank to record lows Tuesday, which should put more downward pressure on home loan rates. The annualized yield on the benchmark Fannie Mae 30-year bond fell to 3.76% from 4.05% on Monday and 4.73% as recently as Dec. 5.

The Federal Reserve this week made good on its promise to begin buying mortgage bonds for its own portfolio, in an attempt to pull home loan rates lower. The average 30-year mortgage rate was 5.10% last week, according to Freddie Mac, and could fall under 5% this week.

The drop in mortgage bond yields is ‘extremely important, obviously, and if continued will contribute to an end to the financial and economic crisis,’ said Tony Crescenzi, bond strategist at Miller Tabak & Co. in New York.

--- In the corporate bond market, the yield on an index of 100 junk bonds tumbled to 13.42% on Tuesday from 14.06% on Monday. The recent peak was 17.70% on Dec. 12. The plunge in yields has driven up bond prices, boosting share values of popular junk bond mutual funds. The T. Rowe Price High Yield fund has surged 9.7% since Dec. 16.

--- In the municipal bond market, the tax-free yield on the Bond Buyer index of 40 long-term bonds has fallen to 5.92% from 6.60% in mid-December.

The question is whether investors are moving back into riskier securities too early. The economic data remain dismal, and the Fed’s report Tuesday of the minutes of its last meeting showed that some policymakers feared a ‘prolonged contraction’ of the economy.

The government on Friday will report December employment numbers. Economists’ consensus forecast is that the nation lost 500,000 more jobs last month.

If fears of a deeper economic crash take hold again, spooked investors may quickly run back to Treasury securities, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, N.J. That could drive yields on the bonds down to levels that would rival those on Japanese government bonds, he said.

The current yield on 10-year Japanese notes is 1.26%, about half the yield of its U.S. counterpart.

Uncle Sam would save a lot borrowing at Japanese yields. But that isn’t the kind of savings taxpayers should be hoping for.

-- Tom Petruno