Wednesday, October 29, 2008

Bonds bet rate cut won't help

U.S. Treasurys rose early Wednesday ahead of an anticipated rate cut by the Federal Reserve, as investors worried that the government's intervention may not be enough to stave off a recession.

Economists expect the Fed to cut its key funds rate by a half percentage point to 1% at the conclusion of its two-day meeting Wednesday afternoon. With the U.S. economy embroiled in a a dire and expensive credit crisis, some even predict a cut to 0.75%, which would mark the lowest level for the fed funds rate in its 53-year history.

The Fed cuts rates to boost the economy. Treasurys usually sell off when rate cuts are expected, as they tend to be inflationary. But with commodity prices plummeting and an economy that is in or entering a recession, inflation fears have subsided.

The benchmark 10-year note rose 5/32 to 101-15/32, and its yield fell to 3.82% from 3.84% late Tuesday. Bond prices and yields move in opposite directions.

The 30-year bond gained 6/32 to 105 14/32, and its yield sank to 4.18%, down from 4.21%.

The 2-year note gained 5/32 to 99-27/32, and its yield fell to 1.59% from 1.66% late Tuesday.

In order to finance more than $1 trillion in financial bailouts and corporate debt purchases, the Treasury auctioned off $34 billion in 2-year notes Tuesday, and will auction $24 billion in 5-year notes on Thursday.

The yield on the 3-month bill fell to 0.72% from 0.74% on Tuesday.

The yield on the 3-month Treasury bill is closely watched as an immediate reading on investor confidence. Investors and money-market funds shuffle money into and out of the 3-month bill frequently, as they assess risk in the rest of the marketplace. A higher yield indicates that investors are slightly more optimistic.

Treasurys were much lower Tuesday as global stocks reversed their recent downward trend and a late day rally on Wall Street sent the Dow surging 889 points.
Signs of improvement

Many economists are calling for the Fed to cut rates to historic lows, because lending to and from financial institutions remains tight. But early indications show the Fed's other attempts to ease financing concerns for financial institutions were working.

On Monday, the Fed's effort to boost short-term financing concerns for companies was reflected in a record amount of commercial paper issued.

The Fed said commercial paper issued Monday with maturities of more than 80 days rose to $67.1 billion from $7.4 billion on Friday and $3.6 billion on Thursday. It was the largest amount of long-term corporate debt purchased in one day since the Fed began maintaining records in 2001.

Commercial paper is short-term debt that big businesses and financial institutions sell primarily to money-market fund managers and other institutional investors. The companies use the loans to fund day-to-day business operations, but the market dried up, particularly for three-month paper, after the collapse of Lehman Brothers in mid-September.
Lending rates

The Fed is offering competitive rates in its commercial paper program. Many analysts, including Bill Gross, the chief investment officer for Pimco, have said the Fed's offer of low 3-month commercial paper rates will help nudge other rates lower, including 3-month Libor rates. That would be a major boost for the strangled credit market, as more than $350 trillion is assets are tied to Libor.

The 3-month Libor rate nudged lower to 3.42% from 3.47% on Tuesday, and the overnight Libor rate fell for the third-straight day to 1.14% from 1.24% on Tuesday, according to Dow Jones.

Lending rates have been trending downward for nearly two weeks. Libor is a daily average of what 16 different banks charge other banks to lend money in London.

As rates fell, two key indicators of risk sentiment showed that confidence in the market was rebounding.

The "TED spread" fell to 2.69 percentage points from 2.71 points on Tuesday. The TED spread measures the difference between the 3-month Libor and the 3-month Treasury bill, and is a key indicator of risk. The lower the spread, the more willing investors are to take risks.

Another indicator, the Libor-OIS spread, eased to 2.58 percentage points from 2.61 points Tuesday. The spread measures how much cash is available for lending between banks, and is used for determining lending rates. The bigger the spread, the less cash is available for lending

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