US Treasuries surged higher on Wednesday as falling stocks, a plunging dollar and record high oil prices spooked investors and sent them scurrying into safe-haven government bonds.
The toxic mix indicated markets might need another dose of interest rate cuts to calm fears, and data showing strong worker productivity suggested the Federal Reserve has the leeway to ease monetary policy without sparking inflation.
US stocks tumbled as a probe of the home loan industry by New York's attorney general opened yet another grim chapter in the tale of the housing debacle, while Washington Mutual Inc, the largest US savings and loan, warned the sector's downturn would extend well into next year.
The dour sentiment in other markets boosted the allure of low-risk bonds, helping an auction of benchmark 10-year notes even as investors fretted over suggestions that key buyer China might reduce its holdings of US government debt.
"This is not a reaction to what the economy is doing. It is a reaction to fear of what may happen in the future," Mary Beth Fisher, strategist with UBS in Stamford, Connecticut, said about the Treasuries rally.
"There is a tremendous amount of risk aversion right now and simply an unwillingness to put on big trades or try to make money." New York Attorney General Andrew Cuomo said his office was sending subpoenas to government-sponsored mortgage financiers Fannie Mae and Freddie Mac as part of a probe of the home loan industry. Two-year notes, which gain when investors put on bets for Fed rate cuts and also on safe-haven flows, surged 8/32, pushing yields down to 3.58 percent. During the rally, two-year yields fell to their lowest level in more than two years.
Prices on 10-year notes rose 15/32 for a yield of 4.32 percent. Analysts said the dollar's weakness could be bad for Treasuries in the long run by spurring inflation and scaring foreign investors away from the market.
This explained a general preference for shorter-dated maturities. The trend further steepened the yield curve, driving the spread between 10- and two-year notes out to 75 basis points, the widest in more than two years. In this environment, long bonds had a tougher slog but still managed to gain. Prices on 30-year debt rose 7/32 to yield 4.66 percent.
"The curve is continuing to steepen with all the uncertainties out there," said Rick Klingman, managing director of US Treasury trading at BNP Paribas in New York. In another sign of market anxiety, risk premiums reflected in interest rate swaps also rose, with spreads widening sharply. Five-year notes jumped 16/32 in price to yield 3.89 percent. Five-year yields also hit their lowest in more than two years.