Bonds gain as stock sell-off trumps S&P rating slash

HONG KONG: US Treasuries pushed higher on Monday and the yield curve steepened after Standard & Poor's slash in the US AAA credit rating rattled investors already fretting about a slowing global economy and raging euro zone crisis.

The bonds most impacted by the rating downgrade were torn in two directions, with short- and medium-term notes playing their traditional safe-haven role even as long bonds suffered on the country's souring fiscal state.

Asian stocks were slammed on Monday but trimmed some losses as European markets recovered in early trade. The MSCI Asia-Pacific ex-Japan was down 3.2 percent and 13 percent in five trading days, while S&P e-mini futures were down about 1.2 percent.

Investors have rushed into Treasuries over the past week as the shock downgrade in US GDP coupled with the rising threat of a financial crisis in Europe caught off guard hedge funds and portfolio managers who had been shorting the market.

While the S&P action underscored the medium-term challenges facing the United States and its budget deficits, top portfolio managers have all said the move was not impacting how they trade Treasuries or use them for collateral.

Blackrock, the world's largest asset manager, said in a press release that it had no plans to do forced selling of Treasuries or related securities, and that it believed the Federal Reserve would support the economy "in any manner it can in light of an extraordinarily anaemic real growth rate."

Rather than hitting Treasuries, the move by S&P compounded the uncertainty already facing investors who have rushed to dump stocks and risky assets in their portfolios, sparking the biggest equity sell-off since the financial crisis.

Even the payrolls data showing slightly stronger hiring than expected and upward revisions in previous months did little to reassure investors fretting that the US economy is teetering close to a recession.

Analysts noted that while the S&P rating cut may prompt central banks to further diversify away from the dollar and Treasuries, a deeper dollar drop may force them to load up on more dollars and even Treasuries.

"The immediate impact will be limited since there is no real alternative to holding US Treasuries for banks and investors which have dollar assets," said Guy Stear, a strategist at Societe Generale.

"With the dollar declining, Asian central banks may ironically be buying more dollars ... and a big chunk of those dollars will have to end up in Treasuries.

Bond strategists at CRT Capital said that portfolio manager need for duration, asset allocations away from riskier assets, the possibility of more Fed easing, central bank buying will benefit the "belly" -- five-year to 10-year sector -- the most.

In an interview, Rick Rieder -- Blackrock's chief investment officer for fixed-income -- said that it is looking for opportunities in US mortgage agency bonds and were good options as high-quality and highly liquid bonds.

September T-note futures were up 8.5/32 at 127-10/32 on heavy volume of nearly 150,000 lots.

Two-year notes were up 2/32 in price to yield 0.256 percent, down about 4 basis points to hit a record low on TradeWeb. Ten-year notes were up 11/32 to yield 2.524 percent, down about 4 bps. Thirty-year bond yields were 2.5 bps lower at 3.822 percent.

The 10s/30s yield curve steepened about a bp to 129.5 bps.

STRONG VOLUMES IN CASH

Cash volumes were also strong in Asia trade. On Brokertec, 10-year and five-year notes were the most active. Friday's volume in five-year notes was about 65 percent above the 20-day average and one of the highest volume days in the past year.

In Europe, the focus was on whether the European Central Bank would step in to buy Italian and Spanish bonds forcefully after having agreed to do so, with investors looking for a strong commitment to help stem the sell-off in those markets.

In the United States, all eyes were turning on the Federal Reserve's meeting this week for any signals the central bank would consider a third round of bond purchases to help revive a flagging economy.

Some analysts noted that the Fed may first opt to extend the maturities of its existing bond holdings rather than make a fresh round of purchases given that economic growth is holding up, if tepid, and companies are still adding workers.

The idea of extending the maturities of the Fed's $1.6 trillion of existing Treasuries -- dubbed 'QE 2.5' by some analysts -- was floated by Brian Sack, head of the New York Fed's Markets division, last month.

Copyright Reuters, 2011