Treasuries Rise on Speculation Credit-Market Losses to Deepen

Bloomberg News

March 6 (Bloomberg) — Treasuries rose and three-month bill rates fell to the lowest level since 2004 on concern that the Federal Reserve may be unable to prevent credit-market losses from deepening.

Investors sought the safety of government debt as Citigroup Inc. planned to pare its U.S. residential unit’s mortgage and home-equity holdings by about $45 billion over the next year. Bonds briefly pared gains as speculation increased that the government would have to guarantee mortgage agency securities before a Treasury spokesperson said the conjecture was untrue.

“Every day is like the 1987 stock market crash,” said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets in New York, the investment-banking arm of Canada’s biggest lender. “There isn’t a day when you’re not at the edge of your seat. The system is at daily risk.”

The yield on the two-year note fell 13 basis points, or 0.13 percentage point, to 1.50 percent at 4:32 p.m. in New York. The price of the 2 percent security due in February 2010 rose 1/4, or $2.50 per $1,000 face amount, to 100 31/32. The 10-year note’s yield decreased 10 basis points to 3.58 percent.

The three-month bill’s rate dropped 13 basis points to 1.36 percent after touching 1.31 percent, the lowest level since July 2004. The drop pushed the so-called TED spread, the difference between what banks and the government pay for three-month loans, to 1.64 percentage points, the widest amount since Dec. 27.

`Driven by Fear’

“The short end is really being driven by fear,” said Donald Ellenberger, who oversees about $6 billion as co-head of government and mortgage-backed securities at Federated Investors in Pittsburgh.

The cost of exchanging fixed for floating interest-rate payments for two years climbed to a record high as investors sought to lock in rates. The spread between the rate on a two- year interest-rate swap, used to hedge against and speculate on interest-rate swings, and the Treasury two-year note yield, reached 110.06 basis points, the largest since at least November 1988, when Bloomberg began compiling data.

“This is the most illiquid market we’ve ever had, bar none, 9/11, any time in the history of the bond market,” said Thomas Roth, head of U.S. government bond trading at Dresdner Kleinwort in New York. “And it’s not getting better any time soon. We’re going to be living with this for a while.”

Merrill Lynch & Co.’s MOVE index, a measure of expectations for Treasury volatility, increased to 164.9 yesterday, the highest level since Jan. 28, two days before the central bank reduced its lending target by a half-percentage point.

`Screen Prices’

“There’s liquidity but not at the screen prices,” said Brant Carter, managing director of fixed-income retail trading for government and agency bonds in Memphis, Tennessee, at Morgan Keegan Inc. “By the time you make a quote and get an execution, the prices are, depending on the size of the transaction, a tick or a plus away to even more. That hasn’t happened in a long time.”

Ten-year securities yielded 2.07 percentage points more than two-year notes, the most in almost four years, on speculation further interest-rate cuts by the Fed will stoke inflation as commodity prices soar. Oil traded at a record of $105.97 a barrel in New York.

The difference in yield between 10-year notes and similar- maturity Treasury Inflation Protected Securities, or TIPS, climbed to 2.57 percentage points today, the most since August 2006. The difference reflects the rate of inflation traders expect for the next decade.

Negative Real Yield

The yield on two-year notes is almost 1 percentage point below the 2.5 percent annual rate of inflation excluding food and energy through January as reported by the Labor Department. The real yield for two-year Treasuries, or the difference between their interest rate and the pace of inflation, is negative 0.99 percentage point.

“This is not a value play in Treasuries,” said Richard Volpe, head of U.S. government bond trading in New York at Bear Stearns Cos., on Bloomberg Television. “This is about preservation of capital.”

Fed funds futures on the Chicago Board of Trade show a 72 percent chance the Fed will lower the 3 percent target rate for overnight lending between banks by three-quarters of a percentage point, compared with 54 percent odds yesterday. The balance of bets is for a cut of a half-percentage point.

Geithner on Stress

New York Fed President Timothy Geithner said the central bank may need to keep interest rates low for “some time” if financial markets remain under stress. The New York Fed president is a permanent voter on the rate-setting Federal Open Market Committee.

The cost of protecting corporate bonds from default rose, with credit-default swaps on the benchmark CDX North America Investment-Grade Index increasing 4 basis points to 170 basis points, according to broker Phoenix Partners Group.

Citigroup’s CitiMortgage division will decrease its total holdings mainly by making fewer loans that can’t be sold, CitiMortgage President Bill Beckmann said. Moody’s Investors Service downgraded bond insurer CIFG Guaranty four levels to A1, citing its “significant exposure to the mortgage sector.”

Bloomberg News By Daniel Kruger and Deborah Finestone

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