Debt Anxiety Severs Some Usual Bonds In Markets

By TOM LAURICELLA And MARK GONGLOFF

Sovereign-debt jitters hit global markets, sending the dollar skyrocketing against the euro, Treasury prices sharply lower and stocks into retreat.

Much of the action was in the currency and bond markets, where worries about the debt crisis in Europe coupled with concerns about the ballooning supply of Treasurys. That spilled over into stocks, which had just clocked 10 gains in 11 trading days. Having just touched fresh 18-month highs on Tuesday, the Dow Jones Industrial Average lost 52.68 points, or 0.5%, to end at 10836.15. Commodities like oil and gold also dropped.

Aside from the size of the moves—10-year Treasurys had their worst day since July and the dollar had its biggest gain in two months—investors also were struck by their direction. Markets that typically move in opposite directions moved together. Treasurys, for example, typically rise when stocks fall; instead they both fell. Similarly, a rising dollar ordinarily might have been accompanied by more demand for Treasurys.

The euro fell to 10-month lows against the dollar after Fitch Ratings downgraded Portugal’s credit rating by one notch and issued a negative outlook for the euro-zone country. In addition, European Union officials continued to wrangle over how to handle Greece’s fiscal woes ahead of a two-day summit starting Thursday.

While the ratings downgrade wasn’t much of a surprise and European officials have been haggling for months, traders said the weight of concerns about the euro’s future finally pushed it below levels it had been holding for weeks. The selloff left the euro at $1.3325, down from $1.3501 late Tuesday.

“The market is growing very uneasy with the lack of certainty,” said Camilla Sutton, currency strategist at Scotia Capital.

The dollar also rallied strongly against the yen, rising to 92.16 yen from 90.41 yen.

“There’s been a broad move toward dollar strength,” said Todd Elmer, a currency strategist at Citigroup.

The dollar’s strength was even more notable given that it came amid broad weakness in Treasurys. Both usually benefit from any flight by investors toward safe assets.

Instead, Treasury prices tumbled, pushing the yield on the 10-year Treasury note, which moves in the opposite direction, to 3.83%, its highest level since Jan. 4. The one-day rise in the yield was the biggest, in percentage points, since July 23.

Some of the selling came as traders were forced to close out bets that rates in the interest-rate swaps market would widen against corresponding Treasury yields.

Some traders had made this bet as swap rates, which measure the cost of exchanging floating-rate corporate debt for fixed-rate debt, fell to nearly even with Treasury yields. Traders believed swap rates couldn’t possibly fall lower. Instead, for the first time on record, 10-year swap rates on Tuesday fell below 10-year Treasury yields, making this a losing bet. Traders unwound it by selling Treasurys.

Making matters worse, a Treasury auction for new five-year debt garnered relatively poor reception, in part because of the continuing decline in Treasurys. The result was a self-reinforcing selloff.

Some observers fear that the market is finally starting to show the strain of absorbing a record flood of new Treasury issuance. One sign of that could be the unusual crossing of swap rates below Treasury yields, which could signal that investors see corporate debt as safer than Treasury debt.

“This is a first sign of stress leading to higher Treasury yields and is not to be missed,” James Caron, head of U.S. interest-rate strategy at Morgan Stanley, said in a note to clients.

For now, though, many other observers suggested the reasons for the move in Treasury yields were mainly technical, including quarter-ending pressures, and that little fundamentally had changed. The peak period of Treasury issuance has probably been reached, swap rates have narrowed relative to Treasurys steadily since last June, and Treasury yields are still within a trading range that has existed for at least that long