US Treasuries prices rose on Tuesday on anxiety over the fiscal and debt problems in Europe, but the bond market was still poised for its worst month since December 2009. Recent safety bids for Treasuries helped to recoup some of the losses from early November as traders cashed out of profitable bets after the Federal Reserve announced on November 3 a second round of bond purchases, dubbed QE2, to stimulate investments and to avert a downward price spiral, known as deflation.
Immediately after the Fed's QE2 move, US politicians and overseas monetary authorities criticised the Fed's decision to pour another $600 billion into the economy as inflationary and a crushing blow for the dollar. "QE1 has put a lot of money into banks, which they are not putting to work, and QE2 is doing more of the same," said Daniel North, chief economist at Euler Hermes ACI in Owings Mills, Maryland, referring to the Fed's first round of bond purchase worth $1.7 trillion last year. "There is enormous inflationary risk."
While the jury is still out on QE2, investors have been buying stocks and riskier assets, which analysts say is a Fed goal to boost household wealth and spending. US fund managers raised their exposure to stocks and reduced their bond holdings for the third straight month on signs the economic recovery is strengthening, a Reuters poll showed on Tuesday.
Tuesday's economic data offered further proof the US economy, while far from robust, is not at the cusp of another round of contraction, as some had feared this summer. A private report showed faster-than-expected factory growth in the Midwest, while another pointed to rising consumer sentiment. The reports curbed initial safe-haven demand for Treasuries as investors demanded higher risk premiums on Spanish and Italian bonds, to euro lifetime highs, and Portugal warned of risks facing its banks.
Benchmark 10-year Treasury notes last traded up 3/32 in price for a yield of 2.80 percent, down from 2.83 percent late Monday. The 10-year note had risen as much as 20/32 on the day. During the month, the 10-year yield rose about 20 basis points, while Barclays Capital's total return index on Treasuries fell 0.87 percent through Monday, the steepest decline since a 2.61 percent drop in December 2009.
Worries over debt problems in Europe spreading have stemmed the QE2-linked sell-off in bonds earlier this month. If the crisis worsens, it will rekindle appetite for less-risky government debt and push benchmark yields back toward 2.50 percent, analysts say. European woes also caused a dramatic widening in the two-year interest-rate swap market as the cost for European financials to access funding in the US dollar market jumped.
The three-month dollar London interbank offered rate (Libor) fixed above 0.3000 percent on Tuesday for first time since August 24. The two-year swap spread, a gauge of confidence in banking system, widened as far as 29.50 basis points, its broadest level since mid-July, for the second time in three sessions, from 24.50 basis points late Friday.
Further widening in two-year swap spreads beyond 30 basis points would indicate that European problems are worsening and probably spark a continued drop in Treasury yields, said Richard Gilhooly, interest rate strategist at TD Securities in New York. "Short of that happening, if stocks turn around and come up on strong data, then we would expect yields to start pushing higher," he said. Late Tuesday, Standard & Poor's said it may downgrade Portugal's 'A-" long-term debt rating.