Bonds Fall as Stocks Steady on Ambac Bailout


Government bond prices extended losses after S&P removed MBIA from negative credit watch and affirmed Ambac's AAA rating.

As the news sent stocks higher, benchmark 10-year notes were down 26/32 and offering a yield of 3.91 percent, up 10 basis points on the day.

Longer-maturity government bonds were especially vulnerable to rising equities. The stock market drew support from the announcement that Dresdner Bank was willing to give millions of euros to the cause of helping Ambac Financial Group keep its top credit ratings.

Other banks are also expected to join the rescue party, although government bond strategists were cautious about selling Treasurys too quickly on what have been so far rather sparse headlines.

"Stocks are up after having been down. I think if you look for anything more than that, you're probably looking too far," said David Ader, Treasury market strategist at RBS Greenwich Capital in Greenwich, Conn.

"It has been very volatile in these last few weeks, but it's still a bloody range. We are not marking new territory one way or the other," he said.

BNP Paribas bond analysts believe that the front end of the curve will likely remain anchored in the near term by expectations the Federal Reserve will not signal further aggressive rate cuts because of lingering inflation pressures.

"We think that the front end of the curve (i.e. the 2-year sector) is more or less anchored, with much less room to move around than intermediate maturities," they wrote in a note.

Five- and 10-year maturities yields should rebound in the meantime based on short-term oversold conditions.

Indeed, the fundamental picture of the economy remains grim. Seen through that lens, the slightly higher-than-expected reading of existing home sales in January, released in a report earlier on Monday was hardly enough to get excited about, strategists said.

"The bad news is priced in and unless we get something that's really unexpected we all know this is the world we are entering with slower growth and credit concerns lingering. We go from one headline to the next," said George Goncalves, chief Treasury/TIPS and agency strategist with Morgan Stanley in New York.

Fed chairman Ben Bernanke is due to testify on the central bank's twice-yearly monetary policy report on Wednesday.

Bernanke is expected to discuss how the Fed can continue lowering rates without risking a flare-up in inflation, after slashing its benchmark federal funds rate by 225 basis points since September to 3.0 percent.

The U.S. government on Friday will release a gauge of inflation favored by the Fed and the median expectation is for an increase.

On the supply front, there are two-year and five-year Treasury auctions on Wednesday and Thursday respectively, although some of the effect of that supply will be offset by redemptions.