Treasury prices surged as investors scrambled for safety after signs the economy may be spiraling into a recession and fears that the housing sector has not yet hit bottom.
The attractiveness of safe-haven government bonds were supported by the latest data on initial jobless claims, which rose to recessionary levels, and by Federal Reserve Chairman Ben Bernanke, who said in testimony that he expects some small bank failuresas a result of the credit crisis. The Fed chief's remarks pushed down major U.S. stock indexes by more than 1 percent.
Some optimism for the housing sector had crept into the market Wednesday after the government lifted limits determining how much the two largest mortgage finance companies -- Fannie Mae and Freddie Mac -- can invest in home loans.
But those hopes were dashed and a safety-first focus set in after Freddie Mac reported a much larger-than-expected loss and Thornburg Mortgage said it faced $2.9 billion in margin calls, lifting Treasuries across the yield curve.
"There's ongoing flight to safety in Treasurys because of credit risk. Equities look softer, and we've got discouraging earnings reports from companies like Freddie Mac," said Kim Rupert, managing director of global fixed-income analysis with Action Economics in San Francisco.
By midday in New York, benchmark 10-year notes were up 34/32, yielding 3.72 percent, down from 3.85 percent late Wednesday. The yield had peaked at 3.96 percent last week, a high for the year and sharply up from the 4-1/2-year low of 3.2850 percent struck last month. Bond yields move inversely to prices.
Two-year paper yielded 1.88 percent, down from 2.01 percent on Wednesday, and was on pace for the lowest close in nearly four years.
These moves kept the spread of the 10-year yield over the two-year at around 184 basis points. Earlier this month, the curve steepened to over 190 basis points, the widest in 3-1/2 years, but that shrank to around 176 basis points last week.
Fear overcame greed in financial markets on Thursday, propelling the price of gold to a record high, pushing the dollar down to an all-time lowand keeping equity markets under pressure.
Government bonds extended overnight gains after a jump in initial claims for unemployment and a rise in continuing claims -- chilling signs that the labor market is suffering.
"The rise in jobless claims (in the week ended Feb. 23) was disappointing. Claims are inching into recession-like territory now that they are getting closer to 375,000 on the four-week moving average," said Cary Leahey, economist and managing director at Decision Economics.
The shift back toward more aggressive rate cut forecasts, after a couple of weeks of trimming back these expectations, put back on the table the market's expectation that the Fed will cut its benchmark rate to 2 percent by the end of the year. Interest rate futures reflected a 38 percent perceived chance that the U.S. central bank could ease by 75 basis points next month.
In testimony before the Senate Banking Committee, Bernanke continued to underscore the need to focus on growth despite rising inflation since slowing economic growth should defuse increasing price pressures.
Some economists agree that this potentially bond-bullish scenario will unfold.
"We agree with the Fed that a potential economy-wide credit crunch risks tipping us into recession and thus should take priority with respect to near-term policy actions," said Joseph LaVorgna, chief U.S. economist with Deutsche Bank in New York.
"When the economy regains momentum, accommodation can be removed rapidly, and inflation pressures (if present) can be thwarted," he said in a note.