August 8, 2011 / 4:06 PM / 6 years ago

U.S. bonds soar on worry about downgrade's impact

NEW YORK (Reuters) - U.S. Treasury prices soared on Monday after the first credit downgrade of U.S. debt caused investors to flee risky assets in favor of bonds on concern over the ripple effects of the ratings cut.

The downgrade underlined the challenges the United States will face in reducing its deficit and the limits it faces in stimulating growth without increasing its already high debt load.

At the same time, investors feared what consequences the downgrade could have across companies, banks and financial markets.

Treasuries benefited at the expense of risky assets including stocks, as investors maintained confidence that U.S. government debt may still be among the world’s safest assets, if no longer risk free.

Standard & Poor’s cut the debt to AA-plus, the second highest ranking.

“Treasuries are still a comparatively low-risk asset. I think there’s no doubt about that,” said Michael Schumacher, a strategist at UBS in Stamford, Connecticut.

Fears over slowing global growth, in tandem with the still-unresolved turmoil in the euro zone, have led investors to flood safe havens that in some cases have been unable to cope.

The Swiss National Bank last week announced a shock interest rate cut in a bid to stem flows into the country that have sent the Swiss franc soaring. BNY Mellon (BK.N) also said it would implement a new fee for some large deposits, citing “sudden, significant increases” in funds.

With over $9 trillion in marketable Treasuries outstanding, the U.S. debt market is one of few able to meet the demand.

Most analysts are confident S&P’s downgrade will not provoke forced selling of Treasuries, and they also said the ratings cut was also likely anticipated by many in the market.

“Most people in the bond market thought that while the timing might be a little more distant, at least there was a chance that the U.S. would be downgraded in the next few months,” Schumacher said. “On the equity side it seems to have been more of a surprise.”

Benchmark 10-year notes at one point soared over two points in price, with yields falling as low as 2.33 percent, the lowest level since February 2009.

Two-year and three-year Treasury yields also fell to record lows of 0.23 percent and 0.38 percent, respectively.

The cost of insuring U.S. debt in the credit default swap market was also stable at around 57 basis points, or $57,000 per $10 million in Treasuries insured, for five years.

“The CDS market has been pricing the U.S. credit as an AA credit for some time,” said Otis Casey, director of credit research at Markit in New York.

U.S. CDS had traded below 2 basis points until late 2007, when concerns about the need for government spending to bail out financial institutions began. Fears over the rising debt burdens of governments have increased since this time.

“There is not a concept anymore of a risk-free rate,” Casey added.


Despite the rally, the gap between 10-year bonds and 30-year bonds expanded, and this yield curve may steepen further as the bond is most vulnerable to long-term U.S. fiscal concerns.

The bonds may also need to offer higher yields to attract buyers to a new sale of the debt this week.

The Treasury will sell $32 billion in three-year notes on Tuesday, $24 billion in 10-year notes on Wednesday, and $16 billion in 30-year bonds on Thursday.

The bond auction “could be a bit of a test for the market,” said UBS’ Schumacher.

The Federal Reserve on Tuesday will also hold its policy meeting where investors will be looking for any signs of further support for the economy.

Treasuries with maturities between 3 years and 5 years have seen strong flows in the past few weeks, he said.

However, “we expect the long end to perform relatively poorly since many people view it as a barometer of U.S. fiscal policy,” Schumacher said.

The gap between 10-year notes and 30-year bonds widened to 132 basis points on Monday from 128 basis points on Friday.

Additional reporting by Richard Leong and Emily Flitter; Editing by Kenneth Barry

Our Standards:The Thomson Reuters Trust Principles.
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