Treasuries Rally, Led by 2-Year Notes, After Emergency Fed Cut

By Sandra Hernandez and Deborah Finestone


Jan. 22 (Bloomberg) -- Treasury notes rallied, led by two- year securities, as the Federal Reserve unexpectedly cut interest rates to head off a recession.

Two-year notes surged the most since Sept. 13, 2001, the day the Treasury market reopened after the terrorist attacks in the U.S., as traders started betting the Fed will push its target even lower at its meeting scheduled for Jan. 29-30. Ten- year note yields fell to the lowest since mid-2003 after the central bank lowered the benchmark rate to 3.5 percent from 4.25 percent and cited ``increasing downside risks to growth.''

``This was a dramatic move intended to be a shock to the markets,'' said Jerry Webman, head of fixed income in New York at Oppenheimer Funds Inc., which manages about $220 billion, in an interview on Bloomberg Television. ``The risk of a recession is very much with us. The two-year yield is showing people think the Fed will ease again.''

The two-year Treasury yield fell 34 basis points to 2.00 percent as of 5:02 p.m. in New York, the biggest drop since it plunged 53 basis points on Sept. 13, 2001, according to bond broker Cantor Fitzgerald LP. The yield touched 1.99 percent, the lowest since April 2004. The price of the 3 1/4 percent security due in December 2009 rose about 5/8, or $6.25 per $1,000 face amount, to 102 11/32. A basis point is 0.01 percentage point.

Demand for safety amid the longest losing streak in U.S. stocks in 11 months drove three-month bill yields to the lowest since January 2005. They fell 55 basis points to 2.28 percent, the biggest drop since Aug. 20. The benchmark 10-year note yield fell as low as 3.43 percent.

`About Time'

Two-year notes rallied the past five weeks, driving yields down almost a percentage point, as the jobless rate rose to a two-year high of 5 percent and manufacturing contracted, fueling bets the Fed wouldn't wait until Jan. 30 to cut borrowing costs.

At BNP Paribas Securities Corp. in New York, two traders yelled ``It's about time,'' in response to the Fed's move, said Jeffry Feigenwinter, head of Treasury trading at the firm, one of the 20 primary securities dealers that trade with the Fed.

Fed policy makers last cut their benchmark rate between meetings on Sept. 17, 2001, when they reduced the target by 50 basis points. After the last four inter-meeting cuts, in 2001 and 1998, the Fed lowered rates again at its next scheduled meeting.

Futures contracts on the Chicago Board of Trade show an 86 percent chance the central bank will reduce the target rate by 50 basis points on Jan. 30 to 3 percent. A week ago, traders saw no chance the Fed would cut the target below 3.5 percent this month.

Stocks and Bonds

About $514 billion in Treasuries changed hands through ICAP Plc, the world's biggest broker of trades between banks, the most since Aug. 16. The six-month daily average is about $336 billion.

``When you have a day like this and surprise people with a cut those expectations go even lower,'' said Jay Mueller, who manages about $3 billion of bonds in Milwaukee at Wells Fargo Capital Management. ``It's a ratcheting down of how far the fed funds rate can go.''

The Fed will cut its benchmark a half-percentage point next week, according to primary dealers Barclays Capital Inc, Credit Suisse Securities, Deutsche Bank Securities, and Goldman Sachs Group Inc.

Treasuries extended gains in late afternoon trading as Apple Inc. tumbled after it gave a profit forecast that missed analysts' estimates. Apple fell $13.64 to $142 in extended trading. The company made the announcement after the Standard & Poor's 500 index fell a fifth day, by 1.1 percent. Growing evidence the economy is slowing has dragged stock indexes from Tokyo to Paris down at least 20 percent from their highs and erased $7.3 trillion in global stock-market value this year.

Bonds and TIPS

The 30-year Treasury yield fell to 4.215 percent, the lowest since July 2005, and inflation-linked Treasuries underperformed as concern faded that Fed rate cuts will revive the economy and spur inflation.

Treasury Inflation-Protected Securities maturing in 10 years yielded 2.2 percentage points less than regular 10-year notes, the smallest gap since 2003. The difference, or breakeven rate, reflects the inflation rate traders expect over the next decade.

The Fed is ``obviously still concerned about inflation, but that's on the back burner,'' said Dan Fuss, vice chairman at Loomis Sayles & Co. in Boston. Loomis' Bond Fund, with $16 billion in assets, has returned 11.9 percent on average the past five years, beating 99 percent of its peers, according to Bloomberg data.

`Safety-Only'

Two-year notes yielded 143 basis points less then 10-year notes, the biggest gap since 2004. A steeper yield curve indicates investors are favoring short-maturity debt over longer-dated securities in anticipation of lower interest rates.

The risk of companies defaulting on their debt soared on concern that the Fed's cut will fail to halt a worsening global economic slowdown, credit-default swaps show. Contracts on the Markit CDX North America Investment-Grade Index climbed as much as 17 basis points to 127, before falling back to 115.5, according to Deutsche Bank AG. A rise indicates deterioration in the perception of credit quality.

``You would have to think the Treasury rally is almost over,'' said Bill Gross, manager of the $112.7 billion Total Return bond fund at Pacific Investment Management Co. in Newport Beach, California, in an interview with Bloomberg Television. ``It's a safety-only type of vehicle at the moment.''

Treasuries have returned 2.3 percent since Dec. 31, the best start to a year since at least 1986, according to an index compiled by Merrill Lynch & Co.