US Treasury prices rose on Thursday as investors shunned riskier assets for the safety of government bonds on signs that turmoil in US credit markets has spread abroad. The seizing up of credit availability overnight in Europe prompted Europe's central bank to provide a record cash injection and led to US stocks falling and the rally in the safe-haven US Treasury market.
But long-dated bonds pared their early price gains following weak demand at a $9 billion auction of 30-year debt. The new issue of the benchmark 10-year note US10YT=RR, which was sold in a Treasury auction on Wednesday, traded down 7 basis points in yield, at 4.79 percent. Bond yields and prices move inversely.
The yield curve, or gap of the 10-year note's yield above the 2-year note's, widened to the steepest since September 2005, as investors snapped up two-year notes on bets the Federal Reserve might bring forward an interest rate cut.
"Probably the No 1 factor creating a strong bid in the Treasury market is the announcement that the ECB was adding liquidity in Europe to ease a credit crunch there," said John Miller, head of fund management of Nuveen Investments in Chicago.
"The flight to quality is exacerbated by the fall in the stock market," he added.
The Dow Jones industrial average fell nearly 2 percent in afternoon trade.
At the Treasury's auction of new long bonds, the bid-to-cover ratio, an indication of demand, was 1.57, well below that in the previous auction of 30-year notes in February. Indirect bidders, which include foreign central banks, took about 12 percent of the auction, down from about 42 percent in the previous auction.
The 30-year bond US30YT=RR traded up 8/32 in price for a yield of 5.05 percent, versus 5.01 percent just before the auction and versus 5.05 percent late on Wednesday.
"The auction was garbage, but expectations were pretty low coming into it," said Beth Malloy, bond market analyst at Briefing.com in Chicago. "As far as the market's reaction, we should be able to recover fairly well, especially since the fundamentals of the day have not changed. What gave us our initial bid is still out there," she said.
Falling stocks, credit concerns and increased bets for a Fed rate cut in the next few months fuelled the Treasuries rally, analysts said. The two-year note - which is particularly sensitive to market expectations on official changes in interest rates - traded up 10/32 in price US2YT=RR for a yield of 4.50 percent, versus 4.67 percent late on Wednesday.
US interest rate futures shifted abruptly amid the credit market turmoil to show a surge in bets for a Federal Reserve rate cut by September. They implied a 62 percent chance that the Federal Reserve will cut benchmark interest rates at its September meeting, up from about 20 percent late on Wednesday. An October rate cut is fully priced in, while futures suggest about a one-in-two chance the Fed will lower rates by 50 basis points by year end.
The Fed added temporary reserves to the US banking system on Thursday through two repurchase operations worth a combined $24 billion. The Fed typically conducts two repo operations on Thursday, but the day's add was higher than usual. The European Central Bank injected nearly 95 billion euros ($130 billion) into euro-zone money markets on Thursday to help calm to jittery markets roiled by credit problems.
The 10-year US interest rate swap spread widened sharply, reflecting investors' heightened risk aversion, to 69.25 basis points from 66.50 basis points late on Wednesday.