Wednesday, July 20, 2011

US Long Bond Rallies On Debt-Ceiling Hopes

US Long Bond Rallies On Debt-Ceiling Hopes

By Cynthia Lin

NEW YORK (Dow Jones)--A surge of optimism Tuesday about the U.S. government making progress toward a budget deal helped 30-year Treasurys recoup sharp losses suffered in the previous session, to post their strongest session in more than four months.

President Barack Obama's mid-afternoon remarks included praise for a sweeping deficit-reduction plan by the so-called "Gang of Six" that involves spending cuts, entitlement-program modifications and tax reforms--all deep-rooted measures that ratings firms are calling for in order to rein in the nation's rising debt load.

The plan, which appeared to garner a flood of bipartisan support, is among the first positive signs that the U.S. debt crisis impasse is finally cracking. Still, some analysts are pessimistic about a solution until they see it officially put in place.

"This is all still so much political theater on everyone's parts, it's pretty horrendous," said Joe Burke, the head of government bond risk management at Interactive Brokers. "It wasn't just surprising that [Treasury bonds] rallied, but how fast it did. If someone were to come out and say they weren't going for it, we'd be right back to where we started."

Aside from the late-day bond rally, the rest of the Treasurys market traded with little conviction because investors struggled to balance the euro-zone debt crisis against the still-unsigned U.S. debt deal. Treasury notes hovered around par for most of the session despite a strong jump in U.S. stocks helped by a better-than-expected jump in June U.S. housing starts.

The debt ceiling debate "is keeping Treasurys in a holding pattern as people await a resolution," said Scott Sherman, interest rate strategist at Credit Suisse.

For months, investors regarded the U.S. debt limit discussions as trivial, showing little concern that the world's largest country might default on its debt. In fact, Treasurys enjoyed months of heavy buying, fueled by the euro-zone debt crisis that drove investors into safer assets. This came even as the Treasury Department's Aug. 2 deadline for Congress to increase the nation's borrowing limit inched closer and ratings firms had threatened to strip U.S. debt of its top-notch grade.

But investors have started getting uneasy about holding longer-dated U.S. government debt, which would stand to lose the most if market participants lose faith in the value and credibility of Treasurys. It wasn't until Obama's reassurances Tuesday that 30-year bond prices rallied, more than recovering Monday's steep selloff and almost erasing the losses over the past four sessions combined.

Many traders say a technical default would spark a sharp, but short-lived exodus from Treasurys. But they think there are better chances that the debt ceiling is lifted in time and that a longer-term plan to cut fiscal spending will hurt stocks and boost appetite for Treasurys.

Analysts at Nomura recommend buying Treasurys on price dips, maintaining faith that the debt ceiling will be resolved and ongoing euro-zone fears will drive Treasury prices higher. Hartford Investment Management says the debt ceiling debate is adding upward pressure on Treasury yields and expects the benchmark 10-year to go as high as 3.35% in the near-term.

In late-afternoon trading, the 30-year bond rose 1 28/32 in price to yield 4.179%. Benchmark 10-year notes fed off the momentum, rising 10/32 to yield 2.873%. Two-year notes fell 1/32 to yield 0.371%. Bond prices and yields move inversely.

US Swap Spreads Mixed
U.S. two-year swap spread, which measures the differential between the two-year swap rate and two-year Treasury yield and is a main gauge of credit risks, was 0.25 basis point tighter at 29.00 basis points. The 10-year swap spread was 2.75 basis points wider at 14.50 basis points.

3/4% 2-year 100 0/32 dn 1/32 0.371% +1.2BP
1 1/4% 3-Year 100 0/32 dn 1/32 0.622% +0.8BP
2 1/4% 5-year 100 11/32 dn 0/32 1.428% +0.2BP
2 7/8% 7-Year 101 15/32 up 4/32 2.144% -2.2BP
3 5/8% 10-year 102 5/32 up 10/32 2.873% -3.6BP
4 3/4% 30-year 103 11/32 up 1 28/32 4.179% -11.1BP
2-10-Yr Yield Spread: +255.0BPS Vs. +255.2PS
Source: Tradeweb

-By Cynthia Lin, Dow Jones Newswires; 212-416-4403;

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