July 25, 2011 / 7:45 PM / 6 years ago

TREASURIES-Divided Congress spurs selling in nervous bond mkt

* Treasury looks to raise $99 billion through debt sales

* Cost to insure U.S. Treasuries highest since Feb. 2010

* Traders worry over US downgrade even if default averted (Changes lead, adds volume info, updates prices)

By Emily Flitter

NEW YORK, July 25 (Reuters) - Investors sold U.S. Treasuries on Monday after bipartisan talks in Washington to cut the U.S. deficit and raise the legal borrowing limit fell apart and Democrats and Republicans set to working on separate plans.

The breakdown in bipartisan talks increased fears that no legislation would be passed in time to avoid a default on U.S. debt. Federal funding options will run out in nine days. For more, see [ID:nN1E76N0CA]

Both Democrats and Republicans are working on plans to cut spending by more than $1 trillion without raising taxes. In a statement on Monday, U.S. President Barack Obama said spending cuts alone were not sufficient to solve the deficit problem. [ID:nN1E76O12F].

Following the release of Democratic deficit-reduction plan, the White House endorsed the plan put forward by Senate Democratic leader Harry Reid, saying it would remove the cloud of a possible default from the U.S. economy through 2012. [ID:nWNA4602].

Treasury prices fell, with the 30-year bond losing more than a full point in price, but volume was below average, according to data released by ICAP.

“We’re just heading down (to Treasury price lows) on the fact that there’s no new compromise on the debt ceiling today,” said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson in Seattle.

“Where negotiations stand at this point, it’s going to be the 11th hour before they get anything done. I am in that camp that I think that they will, because the ramifications of them not getting it done are so humongous that it’s hard for me to believe our leaders can be that short sighted, to not have an agreement.”

Investors are caught in a bind over their Treasuries holdings. A default or a downgrade of United States’ credit ratings would hurt Treasuries’ values, but investors also don’t want to be caught out if there were to be any worrisome news that would cause a safe-haven stampede, analysts said.

“Players are operating on the margin right now and reacting in the extreme to any headlines,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.

Treasuries prices turned briefly positive in late-morning trading on reports of suspicious packages in Washington. Authorities found no hazards. For more, see [ID:nW1E7IB029]

Monday’s selling was most intense among longer-dated maturities, which signal escalating fears of a U.S. default and the possible loss of the United States’ AAA debt rating.

The 30-year Treasury bond was last down 1-1/32 in price for a yield of 4.32 percent US30YT=RR versus Friday’s close of 4.26 percent. It had traded down as much as 1-14/32, touching a session high yield of 4.35 percent.

Benchmark 10-year notes US10YT=RR were down 9/32 with a yield of 3 percent, up from 2.97 percent late Friday.

Two-year Treasuries US2YT=RR were off 1/32 and yielding 0.42 percent.

CLINGING TO HOPE

Many investors are clinging to the hope that the two major U.S. political parties will reach a compromise to increase the borrowing ceiling -- the major hurdle to raising the debt limit -- and allow the world’s largest economy to avert a default.

In the credit default swap market, the cost to insure against a U.S. default rose to the highest level since February 2010, with the five-year CDS price up 57 basis points.

Investors fear a U.S. default could send U.S. interest rates soaring and prompt a vicious sell-off in stocks and other risky assets, which would hurt an already fragile economy.

The tense atmosphere in Washington over debt reduction has created a risky environment for the sale of new government debt.

The U.S. Treasury plans to sell $99 billion in coupon-bearing debt this week, starting with a $35 billion auction of two-year notes on Tuesday.

But solid bidding for $51 billion in three-month and six-month bills on Monday offered a glimmer of hope that investors still have the stomach for U.S. government debt.

The repurchase market, the key source of funds for Wall Street, also showed signs of investor confidence.

The overnight rates for banks and bond dealers to borrow using their Treasuries as collateral ranged between 3 basis points and 1 basis points on Monday, according to IFR Markets, a unit of ThomsonReuters. The low rates underscored high demand for Treasuries, which are seen as extremely safe at least before the Aug. 2 debt ceiling deadline.

“This scenario has intensified as the debt ceiling drama continues. Large cash pools and demand for short-term, safe collateral is not likely to abate until a debt deal is reached.” said IFR analyst Roseanne Briggen in New York. (Additional reporting by Richard Leong and Karen Brettell); (Editing by Theodore d‘Afflisio)

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