US Treasury debt prices rose in thin trade on Friday, with benchmark yields briefly dipping to nine-month troughs, as a plunge in the dollar caused some investors to switch from stocks into government bonds.
But the flight-to-safety flows of money were seen as temporary given that sustained dollar weakness would make Treasuries less attractive to foreigners over time, prompting some profit-taking toward the end of a short trading session. Price moves were exaggerated by the thin post-Thanksgiving holiday volumes.
The dollar plumbed a 1-1/2 year low against the euro after the vice governor of the People's Bank of China, Wu Xiaoling, warned Asian countries against holding too many reserves in dollars.
"The drop in stocks has seen an asset allocation trade into Treasuries. Light holiday trading conditions have helped traders push the market a little bit more than otherwise might have been the case," said Kim Rupert, managing director for global fixed income analysis in Francisco.
The benchmark 10-year note was up 2/32 at 100-18/32 in price for a yield of 4.55 percent at the end of the short trading session, after earlier dropping to 4.53 percent - the lowest level since February 24, according to Reuters data.
On Wednesday, the 10-year note's yield was around 4.56 percent. Bond yields move inversely to their prices. The Treasury market was shut on Thursday for Thanksgiving and closed early on Friday. Traders said while foreign investors could seek a safe haven in Treasuries for now, prolonged dollar weakness would erode their appeal over time as it reduced their monetary value.
"They may be safer buying Treasuries than stocks, but they are not safer from a currency perspective. A dollar, whether it is invested in Treasuries or stocks, is still a dollar," said Adam Brown, co-head of US Treasury trading at Barclays Capital in New York.
Analysts believe that foreign accounts will not start shifting money out of Treasuries just yet, pointing out that government bonds were also firming in line with their European counterparts. "I do not think people will make diversification trades based on what has happened," says George Goncalves, Treasury and agency trading strategist with Banc of America Securities, New York.
The euro's rise above $1.31 for the first time in 18 months boosted Eurozone government bonds, with the positive sentiment spilling over into US Treasuries. Xiaoling said in an academic paper that East Asian nations' reserves were at risk from too much exposure to the falling dollar.
Investors are wary that China, which holds the world's biggest foreign-exchange reserves totalling above $1 trillion, might diversify out of dollar assets. Such speculation helped the euro hit a record high above $1.36 in late 2004. "Overnight flows have seen some official and bank buying in intermediates out of Asia," said William O'Donnell, head of interest-rate strategy at UBS Securities in Stamford, Connecticut.
Given that all Treasury yields are trading below the fed funds rate of 5.25 percent, traders said it was unlikely that investors would shun equities on a large scale for government bonds. "The bond market is very expensive relative to equities, so it's unlikely that you will see a big switch," said one New York-based trader.
The 30-year bond rose 8/32 in price to 97-28/32, while its yield fell to 4.63 percent from 4.65 percent late on Wednesday. The two-year note gained 1/32 in price to 100-8/32, with its yield slipping to 4.74 percent from 4.75 percent late on Wednesday.
The Dow Jones industrial average ended the short trading session 46.78 points, or 0.38 percent at 12,280.17. The Standard & Poor's 500 Index was down 5.14 points, or 0.37 percent, at 1,400.95. The Nasdaq Composite Index finished 5.72 points, or 0.23 percent lower at 2,460.26.