Bonds Rise on Credit Worries, ISM Curbs Gain

U.S. Treasurys advanced Monday as safe-haven buying intensified on worries about subprime mortgage losses and write-downs, but gains were capped after data showed the factory sector was still expanding.

Financial markets remained skittish about the ongoing deterioration in the housing and credit markets, which traders have been betting would result in the Federal Reserve trimming interest rates in the coming months.

"The Fed needs to keep rates down because these subprime mortgages...people can't afford these mortgages if their rates rise," said J.J. Burns, president of J.J. Burns & Co in Melville, New York.

On Monday, Treasury Secretary Henry Paulson said the federal government andthe mortgage industry are close to a rescue plan for subprime borrowersthat will be aimed at curbing loan delinquencies and defaults.

"The market is clearly tense. The credit contagion continues," said William O'Donnell, director of interest rate strategy at UBS Securities in Stamford, Connecticut.

Benchmark 10-year notes were up 15/32 in price for a 3.89 percent yield, down 6 basis points from late Friday. Two-year debt traded up 6/32 to yield 2.92 percent, down 10 basis points from late Friday. Bond yields move inversely to prices.

Credit Jitters

Credit nervousness has been reflected by the resurgence in what banks charge one another for loans. For example, the three-month London Interbank Offered Rate (Libor) edged up to 5.14063 percent, its highest level since mid-October, up from 5.13125 percent on Friday.

Investors are also fearful of being stung by more debt downgrades. Moody's Investors Service late Friday said it lowered or may lower ratings for over $100 billion of securities issued by structured investment vehicles, which invested heavily in subprime loans, analysts said.

This anxiety has overshadowed a slightly stronger than expected report on national manufacturing activity, analysts said.

The Institute for Supply Management's manufacturing index fell for a fifth straight monthto 50.8 in November, compared with 50.9 in October and a median forecast of 50.5. A reading above 50 means the factory sector is growing.

Analysts had predicted manufacturing activity would be bogged down by to the housing slowdown and credit turmoil. Recent weaker-than-expected data, together with more dovish remarks by Fed Chairman Ben Bernanke and other U.S. central bank officials, have sent Treasury yields below 4 percent, well below the Fed's federal funds target rate of 4.50 percent.

On Monday, Boston Fed President Eric Rosengren, who is a voter on the Federal Open Market Committee, warned that home foreclosures would worsen, causing the economy to expand "well below" potential in the coming quarters.

San Francisco Fed President Janet Yellen, who is not an FOMC voter this year, was scheduled to offer her economic outlook at 3:30 p.m.

Traders are fully pricing in the prospects that the Fed will lower the key federal funds rate by a quarter percentage point at its Dec 11th meeting. Some are even betting on a half-point cut, according to U.S. interest rate futures.