U.S. Treasuries Climb on Concern Credit-Market Turmoil Widening

By Dakin Campbell


Aug. 25 (Bloomberg) -- Treasuries rose the most in almost two weeks on speculation credit-market turmoil may be widening.

The gains pushed yields on U.S. 10-year notes to the lowest since May 13 as financial stocks fell amid speculation American International Group Inc. will post a loss and Korea Development Bank may be reconsidering a possible bid for Lehman Brothers Holdings Inc. Interest-rate derivatives imply banks are becoming more hesitant to lend.

``This is the longest-running horror movie that any of us has ever had to deal with,'' said T.J. Marta, a fixed-income strategist at RBC Capital Markets in New York, the investment- banking arm of Canada's biggest lender.

The 10-year note yield declined 9 basis points, or 0.09 percentage point, the most since Aug. 12, to 3.78 percent at 4:39 p.m. in New York, according to BGCantor Market Data. The yield touched 3.76 percent. The 4 percent security due in August 2018 rose 3/4, or $7.50 per $1,000 face amount, to 101 26/32.

Two-year yields dropped 9 basis points, also the most since Aug. 12, to 2.33 percent.

The rally comes as the Treasury prepares to auction $32 billion of two-year notes on Aug. 27 and $22 billion of five- year securities Aug. 28. The size of the two-year note sale is a record, and the five-year note auction will be the biggest sale of that maturity since February 2003. Both amounts are $1 billion more than expected last week.

``Even with supply on the horizon, everyone is concerned with the uncertainties,'' said Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania. ``You have the thought of continued credit deterioration within the market. That is an ongoing thorn in everyone's side.''

Credit-Default Swaps

The cost of protecting U.S. corporate bonds from default rose as Credit Suisse Group said AIG may lose $2.41 billion this quarter and as the ninth U.S. bank failure of the year, the collapse of Columbian Bank and Trust Co. of Topeka, Kansas, added fuel to concern subprime losses will worsen.

Credit-default swaps on the Markit CDX North America Investment Grade Index, a benchmark gauge of credit risk linked to the bonds of 125 companies in the U.S. and Canada, rose 4 basis points to 144 basis points, according to prices from broker Phoenix Partners Group and CMA Datavision.

``You keep hearing about continued credit fears,'' said Kevin Flanagan, a Purchase, New York-based fixed-income strategist for Morgan Stanley's individual-investor clients. `We're back into flight-to-quality mode.''

The Standard & Poor's 500 Index dropped 2 percent.

Losses, Writedowns

Banks are charging each other a premium of 78 basis points over what traders predict the Federal Reserve's daily effective federal funds rate will average in the next three months to lend cash. The spread has widened from about 24 basis points in January.

U.S. notes headed for a third straight monthly gain, according to Merrill Lynch & Co.'s U.S. Treasury Master Index, as forecasts called for slowing economic growth and credit- market losses mounted. Treasuries returned 0.9 percent so far in August, the Merrill index shows, after gaining 0.8 percent in June and 0.4 percent in July.

Losses and writedowns on securities related to subprime home loans now exceed $500 billion at financial institutions worldwide, according to data compiled by Bloomberg.

`Biggest Uncertainty'

JPMorgan Chase & Co. said the value of $1.2 billion in preferred shares of government-sponsored enterprises Fannie Mae and Freddie Mac has declined in the third quarter by half. Prices on the securities are volatile as speculation increases about whether a government rescue of the two companies will protect shareholders.

``All eyeballs will be on the GSEs and whatever statement the government makes'' about them, said John Spinello, chief technical strategist in New York at Jefferies Group Inc. ``That remains the biggest uncertainty in the market.''

Treasuries remained higher today even after a National Association of Realtors report showed sales of existing houses in the U.S. rose in July from a 10-year low. The resales increased at an annual pace of 5 million units, versus a revised 4.85 million in June. A Bloomberg News survey forecast a pace of 4.91 million.

Ried, Thunberg & Co.'s sentiment index for the end of December rose to 49 for the seven days ended Aug. 22 from 48 the week before. A reading below 50 means investors anticipate lower prices. The 31 fund managers surveyed by the company, a unit of ICAP Plc, the world's largest inter-dealer broker, manage a combined $1.40 trillion.

Rate Outlook

Futures contracts on the Chicago Board of Trade show the Fed will most likely refrain from raising its 2 percent target rate for overnight lending between banks this year. Traders see an 81 percent chance the Fed will remain on hold through December, up from 25 percent odds a month ago.

Fed Chairman Ben S. Bernanke signaled in a speech Aug. 22 the central bank is relying on slowing growth to contain inflation. The comments, during the Kansas City Fed's conference at Jackson Hole, Wyoming, fueled speculation the central bank will be reluctant to raise rates.

The world's largest economy probably grew at an annualized 2.7 percent in the second quarter, according to a Bloomberg survey of economists before the Commerce Department releases the figure on Aug. 28. Growth will slow to 0.45 percent in the fourth quarter, a separate survey showed.