Aug. 16 (Bloomberg) -- The yield on two-year Treasury notes fell to the lowest in 22 months as investors fled the subprime plagued credit markets.
Yields dropped 0.09 percentage point, the most in a week, while the yield on the three-month Treasury bill fell as much as 0.72 percentage point to 3.38 percent, the largest decline since the stock market crashed in October 1987. Countrywide Financial Corp., the biggest U.S. mortgage lender, tapped an $11.5 billion credit line after its access to short-term financing was curbed.
``There's a lot of fear,'' said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income assets. ``You're seeing a classic flight to quality in addition to a huge move into Treasury bills that we haven't really seen in a long time.''
Two-year note yields fell to 4.21 percent at 4:03 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 4 5/8 percent security due July 2009 rose 5/32, or $1.56 per $1,000 face amount, to 101 24/32. Yields fell to as low as 3.97 percent, the least since September 2005.
Yields on benchmark 10-year notes declined 6 basis points to 4.66 percent, near the lowest since March. The two- and 10- year yield spread widened to 45 basis points. The gap touched 53 basis points, the most since May 2005. Three month Treasury bills pared gains with the yield rebounding to 3.95 percent.
The gap between the two-year Treasury yield and the Federal Reserve's overnight lending rate between banks was 1.05 percentage point, near the widest since March 2001.
`Fear Trumping Fundamentals'
``This is a classic case of fear trumping fundamentals,'' said John Praveen, chief investment strategist in Newark, New Jersey, at Prudential International Investments Advisers LLC, a unit of Prudential Financial Inc. ``We have seen that snowball into a full blown credit crisis.''
The spread, or difference, between three-month bills and the three-month Eurodollar rate which is traditionally a measure of the health of the U.S. economy, rose to as much as 2.03 percentage points, the most since December 1987. The spread was 0.48 percentage point on Aug. 1.
``It's not necessarily because traders expect numerous Fed rate cuts, it's because they want the best credit,'' said Adam Brown, director of Treasury trading at Barclays Capital Inc. in New York, one of 21 primary dealers.
Credit Freeze
Residential Capital LLC, the mortgage-lending unit of GMAC LLC, had its credit rating cut to junk by Moody's Investors Service. Countrywide's rating was reduced to the lowest investment-grade level. In both cases, Moody's cited the ``significant'' decline in the companies access to debt markets.
ABN Amro, Deutsche Bank AG and eight other banks and pension funds agreed to buy asset-backed commercial paper in Canada to ease a credit crunch in the C$120 billion ($112 billion) market. The group of lenders will convert the commercial paper to floating rate notes, and will roll over their maturing commercial paper for 60 days.
Countrywide turned to backup financing amid a housing slump that's forced at least 70 other mortgage companies to close, go bankrupt or put themselves up for sale.
The 10-year spread, or difference in yield, between interest-rate swaps and Treasuries rose to 78.5 basis points, the most since December 2001. The spread has risen from 45.8 basis points on Jan. 5.
In an interest-rate swap, borrowers exchange cash flows derived from fixed- and floating-rate obligations to hedge risk.
The Housing Market
Builders in the U.S. started work on the fewest homes in a decade in July as the industry showed no sign of recovering from the 18-month recession. The greater-than-forecast 6.1 percent decrease to an annual rate of 1.381 million, followed a 1.47 million pace in June, the Commerce Department said today in Washington. Building permits also fell to a 10-year low.
The perceived risk of owning Countrywide's bonds soared today, according to credit-default swap traders who bet on the company's ability to repay its debt. Countrywide five-year credit swaps climbed to as much as 1,025 basis points, a 400 basis-point jump, according to broker Phoenix Partners Group in New York. An increase suggests deteriorating investor confidence.
``Data doesn't matter,'' said Thomas Roth, head of U.S. government bond trading in New York at Dresdner Kleinwort, a primary dealer. ``This is all about the fear of the system ceasing'' to function properly.
The Fed will cut its key rate by year-end to respond to the subprime crisis and slowing U.S. growth, Roth said.
Traders see a 36 percent chance the Fed will lower its overnight rate for loans between banks by half a percentage point to 4.75 percent at its Sept. 18 meeting, from zero odds a week ago, according to interest-rate futures. Bets for the same cut at the Oct. 31 meeting rose to 50 percent from 5.6 percent.
Fed Outlook
William Poole, president of the Federal Reserve Bank of St. Louis, said there's no sign the subprime-mortgage rout is harming the broader economy and an interest-rate cut isn't yet needed.
Barring a ``calamity,'' there is no need to consider an emergency rate cut, Poole said in an interview in the bank's boardroom.
Treasuries returned 1.9 percent including reinvested interest in the past month, compared with a 0.4 percent loss on U.S. corporate bonds, according to Merrill Lynch & Co. indexes. That's already the best monthly gain since August 2004.
The average spread, or extra yield, on emerging-market bonds over Treasuries widened to 2.44 percentage points, according to JPMorgan's EMBI Plus index. The risk premium was the near the most since December 2005.
