Tuesday, February 5, 2008

Treasuries Rise as Service Industries Contract, Stocks Decline

(Bloomberg) -- Treasuries rallied, pushing two-year note yields close to a four-year low, on growing speculation the Federal Reserve will cut interest rates further after a report showed service industries unexpectedly contracted last month.

Two-year notes gained the most in a week as traders bet the central bank will slash its benchmark rate by a half-percentage point next month, the third reduction this year. Yields have tumbled about 2 percentage points since mid-September, when the Fed started lowering rates to avert a recession amid a slumping housing market.

The report ``strongly corroborates people who have already been saying we're in recession,'' said T.J. Marta, a fixed- income strategist at RBC Capital Markets in New York. ``We're going to retest the lows in yields.''

The two-year yield fell about 11 basis points, or 0.11 percentage point, to 1.94 percent at 10:20 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The yield touched 1.837 percent on Jan. 23, the lowest since April 2004. The price of the 2 1/8 percent security due January 2010 rose about 1/4, or $2.50 per $1,000 face amount, to 100 11/32. Ten-year note yields fell 11 basis points to 3.54 percent.

The Institute for Supply Management's non-manufacturing index, which reflects almost 90 percent of the economy, fell to 41.9, the lowest since October 2001, the last time the U.S. was in a recession, from 54.4 the prior month, the Tempe, Arizona- based ISM said. A reading below 50 signals contraction.

100 Percent

Traders now see a 100 percent chance that policy makers will cut their lending target a half-point to 2.5 percent at their next scheduled meeting on March 18, compared with a 68 percent chance yesterday, according to futures on the Chicago Board of Trade.

The gap between two- and 10-year note yields widened to about 1.6 percentage points, the most since September 2004, from 1.58 basis points yesterday. Shorter-maturity notes are more sensitive to Fed rate changes, while debt maturing in 10 years or more is influenced more by inflation expectations.

U.S. stocks fell, increasing demand for the fixed payments on government debt. The Standard & Poor's 500 Index dropped 1.6 percent in early trading.
 

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