US Treasury prices drop

US Treasury debt prices fell on Tuesday after the Federal Reserve left interest rates unchanged and a stock rally, spurred by news that troubled insurer AIG might get help raising capital, sapped the bid for safe-haven US government debt.
Both Treasuries and stocks retreated immediately after the Fed said its policy-making committee had voted to keep interest rates unchanged, disappointing some investors who had hoped the Fed would cut rates. "There were such high expectations that the Fed would cut rates that the market corrected itself when the Fed made no change," said Carl Riccadonna, economist at Deutsche Bank Securities in New York.
But subsequent news that US authorities might finance a rescue of insurer American International Group caused US stocks to bounce one day after their biggest drop in seven years. That also news drained the safety bid for US government debt. "The headlines suggesting that the Fed may be willing to aid AIG sent equities rallying to new highs and pulled the safe-haven bid from Treasuries, sending them lower," said John Canavan, analyst at Stone and McCarthy Research Associates in Princeton, New Jersey.
In the late afternoon, Morgan Stanley reported better-than-expected third-quarter earnings, cutting through some of the intense gloom hanging over the financial sector and further depleting the safe-haven bid for US Treasuries. "The second-largest investment bank reported earnings that were better than expected," said Cary Leahey, economist and managing director at Decision Economics in New York.
"Also, more and more people realised that the Fed statement accompanying the decision to keep rates unchanged was hawkish," Leahey said. "The Fed drew a line in the sand and left the impression that they won't cut rates anytime soon." A revived safety bid trimmed the session's steepest losses late in the day after Bloomberg reported that the US government was considering conservatorship as an option for insurer AIG. The Bloomberg report cited two people briefed on the AIG talks.
At the close, two-year notes were down 3/32, their yields having risen to 1.79 percent from 1.74 percent late on Monday. Benchmark 10-year Treasuries were down 10/32, their yields rising to 3.44 percent from 3.41 percent on Monday. A drop in consumer prices in August of 0.1 percent, the first decline in nearly two years, could give the Fed more leeway to cut interest rates if it wants to do so, said Robert McIntosh, chief economist for Eaton Vance Corp in Boston.