U.S. Treasuries pricey in uneasy times

By Richard Leong

NEW YORK (Reuters) - U.S. Treasuries are pricey, as anxiety over the global credit crunch, together with hopes of the Federal Reserve slashing interest rates, have unleashed a stampede into cash and low-risk government debt.

Some fund managers, rather than stashing money in expensive Treasuries, view opportunities in top-rated corporate bonds and mortgage-backed securities guaranteed by Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz), Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) and the Government National Mortgage Association (Ginnie Mae), which offer higher yields than Treasuries in exchange for a modest pickup in risk.

"Treasuries are by far the most overvalued sector of the bond market and beginning to reflect the full valuation," said Bill Gross, chief investment officer at Pacific Investment Management Company in Newport Beach, California.

Gross spoke at this week's Reuters Investment 2008 Summit in New York.

An example of the overvaluation in the Treasuries market is the sharp 0.94 percentage point discount of the two-year Treasury note yield <US2YT=RR> above the federal funds target rate, which the Fed lowered to 4.25 percent on Tuesday.

Even if the Fed pares the benchmark overnight rate on excess reserves between U.S. banks to 3.00 percent next year, two-year notes are still expensive, according to Gross.

"(If) the Fed is only going to 3 percent, why would anyone buy a two-year (note) close to that same level?" he said.

Traders pushed Treasury yields below the fed funds target rate on expectations that the central bank would act aggressively to combat the economic fallout from the credit crisis and housing slump.

But this week's modest quarter-point rate cut by the Fed and data pointing to an acceleration in inflation pressure resulted in a 0.20 percentage point increase in the two-year yield, which is most sensitive to the Fed policy outlook.

Yields on longer Treasury maturities also rose, with 10-year notes yielding 4.23 percent, up 0.13 percentage point from a week ago.

Given these low Treasury yields, some fund managers are seeking higher-yielding and relatively safe alternatives such as highly rated corporate bonds and mortgage pass-through securities.

"The Treasury market has run so hard. The opportunity is going to be in high-quality passthroughs," Mary Miller, director of fixed income at Baltimore-based T. Rowe Price, said at the Reuters summit.

For instance, 30-year Ginnie Mae mortgage-backed bonds are yielding at least 1 point more than 10-year Treasuries.

Mortgage securities backed by Ginnie Mae carry the full backing of the U.S. government, the same as Treasuries.

(For summit blog: summitnotebook.reuters.com/)

(Reporting by Richard Leong; Editing by Dan Grebler)