TREASURIES-Safety bid lifts T-notes as Cyprus deal spooks market

LONDON, March 18 Mon Mar 18, 2013 7:49am EDT

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LONDON, March 18 (Reuters) - U.S. Treasuries rallied on Monday as investors switched into less risky assets after a bailout deal for Cyprus looked set to force losses on bank depositors, raising new fears over the euro zone debt crisis.

Treasury futures rose to their highest in nearly two weeks at 131-43/64, before pulling back slightly to stand at 131-28/64, still more than half a point higher on the day.

"There's a phenomenal bid out there... the market looked like it was coming off slightly but this is going to be a global risk-off event during the course of the day," a trader said.

The flight to safe-haven assets was sparked by the proposed structure of a bailout for Cyprus which was agreed this weekend by international lenders.

The bailout would be paid for in part by a one-off tax on bank deposits - a significant departure from previous European bailouts where savings were considered sacrosanct.

Cypriot ministers scrambled to revise the plan on Monday, postponing a parliamentary vote to approve it until Tuesday and prolonging the uncertainty for investors.

The deal was seen as a trigger for a rally in less risky assets because of the precedent it may set for any future bailouts needed by the euro zone's larger states, such as Spain and Italy.

"The rescue package seems to have some scope for contagion, and that will keep the markets careful," said Philip Marey, strategist at Rabobank in Utrecht.

"This undermines the depositor guarantee system in the whole euro zone... If you start messing with the deposit guarantee system, then that is also a concern to Spain and Italy and they are considerably larger than Cyprus."

This meant Treasury yields were likely to keep pushing lower over the coming days, overshadowing domestic data releases and, barring any major surprise, the Federal Reserve's two-day policy-setting meeting on starting on Tuesday.

The U.S. central bank looks set to keep buying $85 billion a month in mortgage and Treasury bonds in an effort to encourage investment and bolster a weak economic recovery.

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