Bonds Gain as Fears Over Credit, Housing Take Over
Treasury prices Thursday rose in volatile trade on swirling fears about the credit and housing markets, tearing open interest-rate spreads as investors dumped mortgage-related debt and sought safety.
The steady flow of chilling news, including talk that UBS was trying to offload $24 billion of Alt-A mortgages and an affiliate of private equity firm Carlyle Group failed to meet some margin calls, put dealers on edge and pushed up safe-haven U.S. government debt.
The roller-coaster ride saw bond prices briefly tumble on a rumor that the government would explicitly back the debt issued by mortgage finance companies Fannie Mae and Freddie Mac.
But Treasurys quickly rebounded after the U.S. Treasury Department said the rumor was untrue.
"The big story in the market is the forced liquidation of mortgage securities, which is just driving everything," said Carl Lantz, U.S. interest-rate strategist with Credit Suisse in New York. "It is driving a flight-to-quality bid," he said.
By late morning, the price of the benchmark 10-year note had jumped 24/32 for a yield of 3.59 percent, down from 3.68 percent late Wednesday. Before Thursday, the 10-year yield, which moves inversely to its price, had racked up a string of three consecutive days of gains.
The 2-year note gained 6/32 for a yield of 1.53 percent compared with 1.64 percent late Wednesday.
The spread of the 10-year yield over the 2-year yield widened to 206 basis points, the most since June 2004, as investors continued to put on so-called yield curve steepening trades. The curve between the 2-year yield and the 30-year yield steepened to 304 basis points, the most since April 2004.
Curve steepeners have been the most dominant strategy in the bond market since last summer, as dealers bet lower Federal Reserve interest rates will weigh on short-end yields but fears about inflation on the horizon will push up longer-term yields.
Data out on Thursday showing record home foreclosures and the highest mortgage delinquencies since 1985 in the fourth quarter of 2007 encouraged investors to keep those bets on for now.
"Prospective homeowners are in a behavioral freefall," said Joseph Brusuelas, chief U.S. economist with IDEAGlobal in New York. "They are not willing to make a sizable capital investment with the expectation that home prices will continue to fall at least through 2008 and, in some cases, well into the next decade."
Meanwhile, shockwaves rippling through lending markets sent dealers scurrying to the relative safety of Treasurys.
At one point early in the Thursday session, the spread of yields on Fannie Mae mortgage-backed securities over Treasuries blew out to the most in more than two decades. The spread later narrowed.
Interest-rate swap spreads recovered slightly after the two-year swap spread earlier widened to a record as mortgage investors unraveled their hedges in the volatile market.
"It's the credit concerns once again," said Ralph Manigat, fixed-income analyst with 4Cast in New York. "There's an unrelenting storm of one bad story after another."