October 5, 2008 / 11:54 PM / 11 years ago

TREASURIES-Yields fall on economy, banking woes

SYDNEY, Oct 6 (Reuters) - U.S. Treasury yields fell to two-week lows in Asia on Monday as talk of a potential U.S recession and fresh banking strains in Europe sent investors fleeing equities to the relative safety of sovereign bonds.

Two-year notes US2YT=RR rose 4/32 in price, pushing yields down to 1.52 percent from 1.59 percent late in New York on Friday. The 10-year note US10YT=RR climbed 19/32 in price, taking its yield to 3.52 percent from 3.60 percent.

Stock futures were down SPc1 around 1.5 percent, while the safe-haven Japanese yen and Swiss franc were in demand. Financial stress showed in Europe, with Germany and Denmark having to guarantee bank deposits to calm nerves [nCRISIS], while BNP Paribas (BNPP.PA) bought 75 percent of the banking arm of Fortis FOR.BA.

Hopes for a euro zone interest rate cut grew after European Central Bank Governing Council member Ewald Nowotny said falling inflation and a slowdown in growth were reasons for the ECB to think about a more expansive monetary policy.

The market has already moved to price in a 50 basis-point cut in the Federal Reserve’s 2 percent funds rate at its policy meeting later this month [nFEDAHEAD]. Friday’s payrolls report showing a sharp 159,000 fall in jobs only reinforced expectations for an easing, giving Eurodollars <0#ED:> a big lift on Monday.

Worsening economic fundamentals overshadowed passage of the $700 billion bailout plan, which also did little to ease strains in global money markets.

Funding costs for banks were still rising even as central banks flooded markets with extraordinary amounts of cash. Three-month London Interbank Offered Rates for U.S. dollars rose 13 basis points on Friday to 4.33 percent, painfully far above the Federal Reserve’s 2 percent cash rate.

The spread between LIBOR and average expected fund rates hit another new record around 288 basis points, indicating banks were unwilling to lend to each other and hoarding cash at all costs.

Analysts at BNP Paribas noted the Fed has reacted by lending huge amounts amounts of cash to the banking system, lifting its assets by 31 percent to $1.2 trillion in just two weeks.

“In sum,the Fed has had little or no choice other than to play the role of liquidity provider of last resort,” BNP said in a note to clients.

“While the politicians have wrangled over $700 billion, the Fed has injected close to $300 billion into the financial system in just two weeks.”

To fund this, the Fed has essentially had to print money, boosting the monetary base by $68 billion dollars, an annualised increase of 600 percent in two weeks. That in turn had put downward pressure on the overnight rate, which was trading around 50 basis points below the Fed’s 2 percent target. (Reporting by Wayne Cole; Editing by James Thornhill)

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