Friday 25 January 2008

U.S. Treasury Notes Advance as Drop in Stocks Increases Demand

Jan. 25 (Bloomberg) -- Treasury notes gained, posting their sixth straight weekly advance, as a decline in stocks fueled concern that the U.S. economy will fall into recession.

Traders pushed U.S. government debt to the best start to a year in two decades on speculation the Federal Reserve will cut interest rates by as much as a half-percentage point Jan. 30. Volatility in Treasuries reached the highest in a decade this week as policy makers slashed their target in an emergency move, while stocks had the longest slide since 2002.

``Yields at these levels reflect safe-haven flows,'' said Jane Caron, chief economic strategist in Burlington, Vermont, at Dwight Asset Management Co., which oversees $68 billion of fixed-income assets. ``Treasuries are being used as a parking place for cash worldwide until there's a better sense of global financial-market direction.''

The two-year note yield fell 13 basis points, or 0.13 percentage point, to 2.19 percent at 4:27 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The 3 1/4 percent note due December 2009 rose about 1/4, or $2.50 per $1,000 face value, to 101 31/32. The yield fell 16 basis points from Jan. 18, and the note's six-week gain is the longest since the period to Nov. 30.

The 10-year note yield dropped 14 basis points today to 3.57 percent. The yield touched 3.29 percent this week, the lowest since June 2003, as investors sought shelter from falling stocks. The note's rally is the longest since 2006.

`Move Quickly'

The Standard & Poor's 500 index fell 1.6 percent today. The index surged the past two days, halting a five-day losing streak that fueled speculation the Fed would lower its benchmark rate as much as 0.75 percentage point to 2.75 percent next week. Policy makers lowered the rate by 75 basis points on Jan. 22, the first move between meetings since 2001.

Yields on two-year notes, those most sensitive to expectations about monetary policy, were 138 basis points below 10-year yields, close to the biggest gap since November 2004.

``The bond market is priced for economic weakness or, I'd argue, recession,'' said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York. ``For the Fed's movement to have any impact on the real economy, they have to move quickly.'' He spoke in an interview on Bloomberg Radio.

Economists in a Bloomberg survey published Jan. 9 lowered their median forecast for growth this quarter to 1.1 percent, from 1.5 percent in December.

`Only Attraction'

Treasuries have returned 2.34 percent this month, the best start to a year since at least 1987, according to indexes compiled by Merrill Lynch & Co. Bonds surged on concern that the U.S. housing slump and $133 billion of losses on mortgage- related investments at the world's biggest banks and securities firms will undermine the economy.

``Safety is at a premium,'' said Brant Carter, managing director of fixed-income retail trading for government and agency bonds in Memphis, Tennessee, at Morgan Keegan Inc. ``The preservation of capital is the only attraction to bonds.''

Traders see a 76 percent chance the central bank will lower its benchmark overnight lending rate by 50 basis points to 3 percent on Jan. 30, compared with 42 percent earlier today, futures on the Chicago Board of Trade show. There's a 24 percent chance of a quarter-point cut.

President George W. Bush and House lawmakers yesterday agreed on a $150 billion stimulus package aimed at supporting the economy. About $100 billion would pay for tax rebates to about 117 million families and $50 billion would go toward tax breaks for businesses.

`Triple-Digit Volatility'

Sales of new homes in the U.S. dropped 0.3 percent in December from a 12-year low the previous month, according to a survey by Bloomberg News before the government releases the report on Jan. 28.

Measures to stimulate the economy may stoke inflation, increasing the appeal of Treasury Inflation-Protected Securities, said John Cerra, who manages $13 billion of bonds at TIAA-CREF in New York. ``A Fed that's likely to be stimulating the economy, a government that's involved in a fiscal policy sending checks to people -- it seems to me at some level TIPS are at very low breakevens,'' he said.

Ten-year TIPS yielded 2.22 percentage points less than similar-maturity notes, down 7 basis points from yesterday. The so-called breakeven rate, which reflects investors' inflation expectations over the next decade, fell to a five-year low of 2.04 percentage points on Jan. 22.

Merrill Lynch & Co.'s MOVE index, which measures volatility on Treasury options, climbed to 171.7 yesterday. That's the highest since October 1998, when the Fed cut interest rates between meetings, responding to financial-market turmoil after the collapse of hedge fund Long-Term Capital Management LP.

In another sign of how turbulent trading has been this week, the five-day historical yield volatility on the 3 5/8 percent coupon Treasury maturing in December 2012 reached 132.7 yesterday, from 30.4 on Jan. 10.

``I don't remember triple-digit volatility,'' said Cerra. ``It's really beyond my 23 years of experience.''

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