March 14, 2007 / 8:00 PM / 13 years ago

For safety, cash rules, but only in short term

NEW YORK (Reuters) - Investors fleeing risky assets in the wake of defaults in the U.S. subprime mortgage market are finding a safe haven in cash, but Treasury bonds may be a better if debt-laden consumers slow their spending.

Nervousness about over-priced emerging markets, concern that U.S. mortgage market defaults may slow U.S. consumer spending, and geopolitical worries about tensions between the U.S. and Iran, have resulted in global stock markets falling since late February. Even gold, a traditional safe-haven, has seen its price fall.

For now, with money market funds yielding about 5 percent and the benchmark 10-year Treasury note’s yield at 4.50 percent US10YT=RR, the most attractive investment appears to cash and money market instruments.

The fear that troubles in subprime lending will cascade into the wider economy “tends to drive the retail investor into some cash,” said David Kotok, chairman and chief investment officer of Cumberland Advisors, a money management firm in Vineland, New Jersey.

U.S. money market fund assets rose to a record high $2.392 trillion in the last week, iMoneyNet’s Money Fund Report said on Wednesday.

While the overall average return on taxable money market funds tracked is about 4.75 percent, some of the highest performing retail funds of this type are paying more than 5.0 percent, said Connie Bugbee, managing editor of iMoneyNet.

“That is a healthy safe return. It is not going to vary,” Bugbee said.

U.S. Treasury bond yields have already fallen sharply since late February, touching 3-month lows, as bond investors bet on more than one Federal Reserve interest rate cut this year.

As a result, Michael Cuggino, CEO of Pacific Heights Asset Management in San Francisco, expects the Federal Reserve to hold short term interest rates steady for many months and so reckons investors should be in money market instruments now.

“At the longer end you missed the rally (in Treasury bond prices) two weeks ago,” Cuggino said.

If the Fed were to hold its overnight fed funds rate at 5.25 percent through the end of the year, and the benchmark 10-year yield were to stay around 4.5 percent, then over that period an investor would be better off in cash instruments that pay around 5 percent, he said.

But short-maturity cash instruments don’t provide the opportunity bonds do for price appreciation in a falling rate environment.

Investors with an extended horizon such as bond funds, pension funds, and insurers, are placing long term bets that Treasury notes and bond yields will fall, driving their prices higher, as the economy slows and the Federal Reserve starts to cut interest rates.

“When it becomes apparent you are looking at a rate cut, you probably want to go out longer,” Cuggino said.

Buying of Treasuries this month has come not only from fast moving speculative investors such as hedge funds.

Central banks and other long term global investors have also been buying intermediate maturities and longer dated Treasuries because U.S. interest rates are still higher than those in Japan and the euro zone.

Some market strategists also anticipate that losses in the subprime mortgage sector will have wider repercussions on banks, the consumer and the economy, forcing the Fed to ease policy perhaps before mid-year. For those making that bet, Treasuries are the place to be.

Some big bond investors including bond fund PIMCO have longstanding bets that Treasury yields will fall as the Federal Reserve cuts interest rates in the face of a weakening economy.

“In Treasuries, whenever you feel there is a financial risk you go long because if the Fed has to react to defend the system there is a huge leveraged play on long Treasuries,” said Donald Coxe, global portfolio strategist in Chicago with the BMO Financial Group.

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