Monday, March 17, 2008

Treasuries Rise; 3-Month Bill Rates Fall to Lowest Since 1950s

By Sandra Hernandez and Daniel Kruger


March 17 (Bloomberg) -- Treasuries rose and the three-month bill rate plunged to the lowest since the 1950s as the Federal Reserve cut the discount rate at an emergency weekend meeting and backed JPMorgan Chase & Co.'s deal to buy Bear Stearns Cos.

Gains in two-year securities drove yields to the lowest level in almost five years as the Fed reduced the rate on direct loans to banks by a quarter-percentage point to 3.25 percent. Futures contracts on the Chicago Board of Trade show traders are betting the central bank will slash its target interest rate by at least 1 percentage point tomorrow from 3 percent.

``It's very easy to see it's a flight to quality,'' said Daniel Fuss, 74, the Boston-based vice chairman at Loomis Sayles & Co., who oversees $22 billion and whose firm's Bond Fund has returned 11 percent annually over the past five years, beating 99 percent of its peers, according to Bloomberg data. ``We're in new territory now. Even Alan Greenspan hasn't seen this.''

The two-year note's yield fell 13 basis points, or 0.13 percentage point, to 1.35 percent at 4:33 p.m. in New York, according to bond broker Cantor Fitzgerald LP. It touched 1.24 percent, the lowest level since July 2003. The price of the 2 percent security due in February 2010 rose 1/4, or $2.50 per $1,000 face amount, to 101 1/4.

Investor demand for the relative safety of short-term government debt sent the three-month bill rate down 16 basis points to 1 percent, according to Bloomberg's market average. It touched 0.652 percent, the lowest level since May 1958, when the U.S. was emerging from a recession. The yield on the benchmark 10-year note dropped 15 basis points to 3.32 percent.

`Sheer Terror'

``They're not buying for value, they're buying it out of sheer terror,'' said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., who helps oversee $80 billion in fixed-income assets. ``That can go for a while. Fear is very powerful.''

The shortage of Treasuries in lending markets worsened today. The rate for borrowing and lending non-specific Treasury securities, or the general collateral rate, was 65 basis points below the central bank's target rate for overnight loans, compared with 45 basis points on March 14. The spread has averaged 55 basis points this year and about 8 basis points over the past 10 years.

Treasuries of all maturities have returned 4.6 percent in 2008, the best start to a year since 1995, according to a Merrill Lynch & Co. index. A meltdown in the market for mortgage-backed securities has driven investors to the safety of U.S. government debt. The central bank on March 11 said it would swap $200 billion in Treasuries with its 20 primary dealers for debt including mortgage-backed securities.

Yield Difference

``Most of the community has in some way, shape or form used Treasuries to hedge'' purchases of higher-yielding assets such as municipal and mortgage debt, said Robert Millikan, who manages $5 billion as director of fixed income at BB&T Asset Management in Raleigh, North Carolina. As falling values forced investors and financial firms to sell higher-yielding assets, ``they've had to buy all those Treasuries they've shorted. That's pushing yields lower and prices higher.''

The yield difference, or spread, between two- and 10-year notes was 198 basis points, within 10 basis points of the widest since 2004. The gap reflects greater demand for shorter-term debt, which is more sensitive to changes in interest rates.

``There's no reason to think it can't go to 250 to 275'' basis points, said Jason Stipanov, an interest-rate strategist at Morgan Stanley, one of the 20 primary dealers of U.S. government securities that trade with the Fed. He's advising clients to bet that the yield difference between the notes and that between two- and five-year securities will widen further.

Bid-Offer Spreads

The gap between bids and offers for Treasuries has widened over the past few days, reflecting uncertainty on the part of traders and investors about the fate of financial markets.

``There's absolutely no liquidity whatsoever,'' said Tom di Galoma, head of U.S. Treasury trading at Jefferies & Co., a brokerage for institutional investors in New York. ``If you don't act within a split second, you could lose the bid-offer.'' The last time spreads widened as much was in the aftermath of the terrorist attacks of September 11, 2001, he added.

Low yields and a weak dollar don't appear to be driving international investors away from Treasuries. Foreign buying of U.S. financial assets rose in January as foreign governments bought Treasuries and purchases of stocks slowed.

Total net purchases of Treasury notes and bonds rose to $37.6 billion, from $1.44 billion in December, the Treasury Department said today in Washington. Total holdings of equities, notes and bonds increased by a net $62 billion, from $56.5 billion the previous month.

Dollar Versus Euro

The U.S. dollar dropped to an all-time low versus the euro today and below 96 yen for the first time in 12 years.

Futures contracts show a 74 percent chance the central bank will lower the target rate for overnight loans between banks by a full percentage point tomorrow, compared with 14 percent odds a week ago. There's a 26 percent chance policy makers will cut by 1.25 percentage points.

Primary dealers Citigroup Global Markets Inc. and Deutsche Bank Securities Inc. said the Fed would cut by 1 percentage point in separate notes to clients today.

Treasuries are ``just up on panic buying and expectations the Fed will go more,'' said Sean Murphy, who trades Treasuries in New York at RBC Capital Markets, the investment banking arm of Canada's biggest lender. ``There's nobody looking at this and saying, `There's value here at 1.30 percent on the two-year, I need to buy it.' ''

Bear Stearns Deal

JPMorgan agreed to buy Bear Stearns for $240 million. Shareholders of New York-based Bear Stearns will get stock in JPMorgan equivalent to about $2 a share, compared with $30 at the close on March 14, the two companies said in a statement.

The failure of another financial institution is ``something the market is worried about,'' said Stipanov at Morgan Stanley.

In a sign of reduced willingness by banks to lend, the difference between the rate banks charge for three-month dollar loans relative to the overnight indexed swap rate, the so-called Libor-OIS spread, widened to 2.49 percentage point, the most this year, according to data compiled by Bloomberg. The Fed takes the OIS rate to set the minimum bid at the auctions it uses to make short-term loans to banks.

The cost of borrowing in dollars overnight rose by the most in at least seven years after the Fed's cut in the discount interest rate stoked concern that credit losses are deepening.

The London interbank offered rate, or Libor, climbed 81 basis points to 3.86 percent, the British Bankers' Association said. It was the biggest increase since at least January 2001.

`Default Risks'

``Uncertainty about market positions, default risks and the depth of the U.S. recession remains high,'' Jan Loeys, JPMorgan's London-based global head of market strategy, wrote in a note to clients. ``We stay overweight Treasuries against most spread products in the U.S.'' An overweight position is one in which an investor holds a greater percentage of the securities than contained in the benchmark used to gauge performance.

Investor sentiment toward Treasuries improved last week, Ried, Thunberg & Co. said in its weekly survey of fund managers. An index of sentiment toward 10-year notes through the end of June rose to 51, from 48 last week. A number above 50 signals investors expect Treasury prices to rise. The 33 investors surveyed by the Westport, Connecticut, company manage a combined $1.45 trillion in assets.

The Fed said it will allow primary dealers to borrow at the discount rate in exchange for a ``broad range'' of investment- grade collateral. The central bank, in a statement yesterday in Washington, said it also extended the maximum term of discount- window loans to 90 days from 30 days.

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