TREASURIES-U.S. bonds rise as Washington contest spurs safety bid

Thu Oct 3, 2013 1:48pm EDT

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By Ellen Freilich

NEW YORK, Oct 3 (Reuters) - U.S. Treasuries prices rose and yields eased on Thursday as an ongoing contest in Washington that has shut much of the government and left the debt ceiling problem unresolved inspired investors to buy U.S. debt, still the most viable safe haven.

Given the gridlock over the budget and healthcare reform that led to a partial government shutdown that began on Tuesday, investors are increasingly worried the lawmakers will not agree on a deal to increase the statutory $16.7 trillion borrowing limit by the Oct. 17 deadline.

Failure to increase the debt ceiling, they fear, would unleash market chaos and damage the long-term creditworthiness of the U.S. government and the safe-haven status of the dollar.

"At this point, the market seems to have a pretty high degree of confidence the Treasury will not miss or delay a principal or interest payment - that other things will give before that gives," said Robert Tipp, chief investment strategist at Prudential Fixed Income, with $400 billion in assets under management, in Newark, New Jersey.

"But if that assumption comes into question you will see the orderly repricing that is going on right now become disorderly," he said. "For the market, any significant doubt as to the timely payment of interest or principal on Treasury securities would be tantamount to the earth ceasing to rotate on its axis."

As concerns over a possible U.S. default have intensified, the cost to insure Treasuries has soared in the credit default swaps market, though analysts qualify that by noting that that market is not particularly broad or deep.

Investors would pay about 46,000 euros to insure 10 million euros worth of Treasuries for a year on Thursday, according to Markit. This was the highest premium on one-year U.S. sovereign debt since July 2011 during the first debt ceiling showdown between President Barack Obama and top Republican lawmakers.

BILL YIELD CURVE INVERTS

Another symptom of debt ceiling stress was evident in the inverted bill yield curve. While six-month bill yields normally would be slightly higher than those on shorter-term bills, yields on bills set to mature on Oct. 31, just two weeks after the Oct. 17 date by which the Treasury has said the debt ceiling must be raised, have risen above six-month bill rates.

Interest rates on Treasury bills that will come due between the debt ceiling deadline and the end of October also rose on default worries. The rate on the T-bill issue due Oct. 31 touched 0.17 percent, its highest since November. This compared with 0.03 percent on the T-bill due the following week.

"It's not a big move in bills. No one is really concerned about not getting their payment. But the market is kind of tough right now. People are skittish," said Matthew Duch, portfolio manager at Calvert Investments in Bethesda, Maryland.

That skittishness certainly was evident on Wall Street where major stock indexes fell about 1 percent in morning trade.

The losses on Wall Street encouraged a move to Treasuries, boosting benchmark 10-year notes 5/32 in price as their yields eased to 2.61 from percent from 2.63 percent late on Wednesday, close to a seven-week low.

Strategists cited technical resistance at 2.60 percent for the 10-year yield and said if the yield slipped to trade below that level for a sustained period, the next move would be down to 2.45 percent.

The inability to collect data on the economy during the government shutdown and the likelihood the data would not be that robust once it is published argue against the Federal Reserve being able to accomplish any tapering of its policy to stimulate the economy by keeping interest rates low and buying $85 billion a month in Treasury and mortgage-backed securities.

"We won't have an employment report on Friday and the Fed is very keyed into employment indicators," said Gabriel Mann, U.S. rates strategist at RBS. "If the shutdown goes on, you can all but rule out an October taper announcement."

The longer the shutdown persists, the less probable a December tapering looks, Mann said.

"Also, markets are thin in December and the Fed is cognizant that rising rates could hurt everything they've been trying to accomplish," Mann said. "Tapering in thin markets could cause an even more adverse reaction and a sharper selloff in rates."

With a new Fed chair arriving in January, "we think tapering will be pushed to the March statement," Mann said.

While yields remained lower on the day, they briefly came up from their lows on a report in The New York Times that House Speaker John Boehner, according to one House Republican, has told colleagues that he is determined to prevent a federal default and is willing to pass a measure through a combination of Republican and Democratic votes.

Economic data took a back seat to worries about the political fighting in Washington.

The U.S. Labor Department said jobless claims totaled 308,000 in the week ended Sept. 28, compared with an upwardly revised 307,000 in the previous week. Economists had projected the latest figure to have risen to 313,000.

This was the last government economic report until the partial shutdown ends.

Meanwhile, the Institute for Supply Management index showed the non-manufacturing sector of the economy grew in September, but not as quickly as it did in August.

The Fed bought $1.474 billion in Treasuries that mature between February 2038 and August 2043, part of its intended planned $45 billion in government debt purchases in October.

Also, San Francisco Fed President John Williams, Atlanta Fed President Dennis Lockhart, Dallas Fed President Richard Fisher and Fed Governor Jerome Powell will make public appearances on Thursday.

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