Thursday, March 20, 2008

US Treasurys Rally on Economic Worries

Treasurys Rally As Investors Reach for Safety As Global Concerns Rise Ahead of Holiday Weekend.

Treasurys staged a massive rally Wednesday, as fears about continuing fallout from the credit crisis prompted investors to seek safe assets ahead of a long holiday weekend.

There were positive developments in the U.S. mortgage industry Wednesday as well as the afterglow of a sizable Federal Reserve rate cut the day before. But those encouraging developments were overshadowed by worries that other banks could be in dire straits following the near-collapse of Bear Stearns Cos. Inc. and its stunning $2-a-share takeover by JP Morgan Chase & Co.

There remain troubling signs of weakness at some foreign and domestic banks and those problems helped spark the Treasurys rally. For instance, Switzerland's largest bank UBS AG Tuesday said its chairman, Marcel Ospel, took a 90 percent pay cut for 2007. The bank has been beset by massive writedowns linked to its exposure to the U.S. mortgage market.

The strong demand was compounded by the unwinding of a heavy prior day selloff and by the approach of the three-day market holiday for Easter. Investors often buy low-risk assets and unload risky assets ahead of a long weekend. The bond market will close one hour early on Thursday at 2 p.m. Eastern time Thursday ahead of the holiday.

The benchmark 10-year Treasury note rose 1 to 100 23/32 with a yield of 3.41 percent, down from 3.50 percent late Tuesday, according to BGCantor Market Data. Prices and yields move in opposite directions. The 30-year long bond rose 2 18/32 to 100 30/32 with a yield of 4.26 percent, down from 4.37 percent.

The 2-year note fell 1 to 100 23/32 with a yield of 1.63 percent, unchanged from late Tuesday. More buying in after hours trade sent yields even lower. At 5:30 p.m. Eastern time, the 10-year yield was 3.34 percent, the 30-year yield was 4.20 percent and the 2-year yield was 1.47 percent.

Wednesday's massive buying spree also produced exceptionally heavy demand for short-term bills that pushed some yields down to fractional levels. The 3-month bill yield plunged to 0.63 percent from 0.92 percent Tuesday as the discount rate weakened to 0.62 percent from 0.91 percent. The 1-month yield skidded to 0.24 percent from 0.47 percent as the 6-month yield fell to 1.22 percent from 1.32 percent.

Despite the vigorous fear-driven rally in the Treasury market, there was plenty of goods news for the domestic bond market Wednesday. The government loosened capital requirements for the mortgage-finance companies Fannie Mae and Freddie Mac by cutting their surplus capital requirement to 20 percent from 30 percent.

The move should provide up to $200 billion in new funding to the mortgage securities market. The action followed an unusually large 0.75 percentage point reduction in the Federal funds rate to 2.25 percent Tuesday that was accompanied by a statement that hinted at more rate cuts ahead from the Federal Reserve.

Investors cheered the Fed's bold moves, but were uncertain what the ultimate outcome will be for the fixed-income market. "Bernanke and policy makers are allowing an implosion of the biggest credit bubble in history," said T.J. Marta, a fixed-income analyst at RBC Capital Markets. "You have to run the gauntlet between letting that bubble collapse, but not letting it take out the banking system and the economy -- good luck with that one."

Bond investors also are concerned that the huge rate cuts the Fed has implemented since last summer could accelerate inflation; rising inflation erodes the value of fixed-income investments.

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