Treasury Yield Curve Steepest Since 2005 on Tumble in Stocks

By Sandra Hernandez and Daniel Kruger


Nov. 7 (Bloomberg) -- The difference in yields between Treasury two-year and 10-year notes increased to the widest since 2005 as a decline in stocks and forecasts of deeper mortgage-related losses raised the appeal of government debt.

The two-year yield fell to the lowest since June 2005 after Federal Reserve Bank of St. Louis President William Poole said a housing slump may make further interest-rate cuts necessary. U.S. banks and brokers may face another $100 billion of writedowns on hard-to-value securities, according to Royal Bank of Scotland Group Plc. Stocks fell to the lowest in seven weeks.

``There are ongoing concerns about credit because the stories don't go away,'' said John Spinello, chief fixed-income technical strategist in New York at Jefferies & Co. ``That augurs for safe-haven buying.''

Yields on two-year notes sank 13 basis points, or 0.13 percentage point, to 3.57 percent at 4:04 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 3 5/8 percent securities due in October 2009 rose 1/4, or $2.50 per $1,000 face amount, to 100 3/32. The benchmark 10-year note yielded 4.32 percent. Three-month bill yields fell 30 basis points to 3.44 percent, the lowest since Aug. 21.

``In current circumstances it could be that the downdraft from the housing industry will spread to other sectors, which might require that recent rate cuts not be reversed or even that additional rate cuts would be in order,'' Poole, a voting member on the Federal Open Market Committee this year, said in the text of a speech in Milwaukee.

Fed Bets

The gap between two-and 10-year yields widened 9 basis points to 0.75 percentage point, the most since April 2005.

From no difference in June, the spread between yields on the two maturities has grown as investors speculated banks' losses on subprime mortgage-related assets may slow the economy and prompt the Fed to cut interest rates.

Traders boosted bets the Fed will reduce its target for the overnight lending rate between banks by a quarter-percentage point to 4.25 percent at their Dec. 11 meeting. Futures traded on the Chicago Board of Trade imply 70 percent odds of a 25- basis-point reduction next month, compared with 62 percent yesterday. The central bank lowered the benchmark a quarter- point to 4.5 percent Oct. 31, after a half-point reduction in September, the first since 2003.

Decline in Stocks

U.S. stocks declined after General Motors Corp. posted its biggest loss ever and as shares of Seattle-based Washington Mutual Inc., the largest U.S. savings and loan, fell the most in 20 years. New York Attorney General Andrew Cuomo said he found a ``pattern of collusion'' in mortgage appraisals linked to the company. The stock of the world's largest automaker dropped after the company reported a $39 billion quarterly loss from writing down the value of future tax benefits.

GM's losses ``seem to have the market all riled up,'' said Sean Murphy, a trader in New York at RBC Capital Markets, the investment-banking arm of Canada's biggest bank. ``The market's of the belief the Fed will continue to address this credit crisis.''

Wall Street's biggest firms have written down at least $40 billion as prices of mortgage-related assets plummet because of record foreclosures.

The Financial Accounting Standards Board's rule 157 will make it harder for companies to avoid putting market prices on securities considered hardest to value, known as Level 3 assets, Bob Janjuah, Royal Bank's chief credit strategist in London, wrote in a note today. The new rule is effective Nov. 15, he said.

Falling Dollar

Investors favored shorter-maturity notes, which are less vulnerable to quicker inflation, as the dollar fell to a record $1.4731 per euro and a 26-year low versus the pound. China will invest in stronger currencies when diversifying its $1.43 trillion of foreign-exchange reserves, Cheng Siwei, vice chairman of the National People's Congress, said in a speech in Beijing today. A weaker dollar can boost import prices.

Inflation expectations are close to the highest since June, as measured by the yield difference of regular bonds over Treasury Inflation Protected Securities, or TIPS. Ten-year notes yielded 2.40 percentage points more than similar-maturity TIPS, compared with a gap of 2.19 percentage points in early September. The difference reflects investors' expectations for inflation over the next decade.

The Fed ``has to turn a blind eye to inflation and the dollar until the credit crisis stabilizes,'' said Jay Mueller, who manages about $3 billion of bonds in Menomonee Falls, Wisconsin, at Wells Fargo Capital Management. ``The market knows that, so the curve is steeper.''

In comments before a congressional panel in Washington today, Fed Governor Frederic Mishkin said it is ``extremely important'' to contain inflation.

Ten-year notes also gained as the government's sale of $13 billion of the notes drew a lower yield than some traders expected. The government sold the notes to yield 4.353 percent, the lowest since September 2005 and below the average 4.36 percent forecast of 11 bond-trading firms in a Bloomberg survey.