Business & Finance

US 10-year notes come off lows hit on Moody's warning

SINGAPORE : US 10-year Treasuries held steady on Thursday, showing resilience after Moody's Investors Service warned t
Published July 14, 2011

US treasury noteSINGAPORE: US 10-year Treasuries held steady on Thursday, showing resilience after Moody's Investors Service warned the United States may lose its top-notch credit rating in the next few weeks if lawmakers let the government miss debt payments.

Ten-year notes fell roughly 8/32 in price at the start of Asian trading in the wake of the Moody's announcement, which also dented the dollar.

The drop in 10-year Treasuries was limited, however, with market players taking the Moody's warning in their stride, saying they expected US lawmakers to ultimately raise the country's legal borrowing limit in time and for the US government to avoid defaulting on its debt.

US 10-year Treasury notes were steady in price to yield 2.886 percent. The yield was down from an intraday peak of 2.915 percent hit in early Asian trade, and had eased by 3 basis points from late US trading on Wednesday.

Treasuries "opened a bit lower from where we closed in New York and people took that as an opportunity to buy," said a trader for a US financial institution in Tokyo, adding that there has been a good flow in both directions in Asia.

Ten-year note futures also trimmed their initial losses and were last up 1.5/32 at 124-27/32.

The 10-year yield is down some 40 basis points so far this year, with the euro zone debt crisis, a slowdown in major economies including the United States and volatility in emerging markets providing a strong bid for Treasuries throughout the year.

Moody's said on Wednesday it sees a "rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on US Treasury debt obligations."

The warning was not surprising, given that Moody's had already said in June that it would put the AAA US credit rating on review for a possible downgrade if lawmakers did not make substantive progress in budget talks by the middle of July, said Tomoaki Shishido, rate analyst for Nomura Securities in Tokyo.

The lack of progress in the budget talks as well as the negotiations over the US debt limit is not surprising either, Shishido said, adding that neither the Republicans nor the Democrats can afford to back down easily at this stage.

"Ultimately there is little choice but to raise it (the debt limit)... But in order to make progress toward that conclusion, both sides need to be able to say there were substantial conflicts and that the situation has turned into a crisis," Shishido said.

'FABRICATED CRISIS'

"This is a fabricated crisis, a drama produced for the sake of outward appearances," said Shishido. The debt talks are likely to remain contentious right up to an Aug. 2 deadline, but an agreement to raise the debt ceiling will probably be reached at the last minute, he said.

If an agreement is not reached in time, and the United States fails to make coupon payments on Treasuries or to pay for bond redemptions in time, the impact on the market is likely to be significant, he added.

"I think the market will move a lot. It wouldn't be a surprise if there was a very violent reaction," Shishido said.

The US Treasury Department has said if the debt ceiling is not raised by Aug. 2 it will have to start prioritising payments, and Federal Reserve Chairman Ben Bernanke said on Wednesday the United States will pay creditors first and stop benefits like Social Security payments, if it fails to raise the debt ceiling by that date.

"The only image you can have is one where it is raised at the very last minute," said a portfolio manager for a major Japanese bank in Tokyo, referring to the debt limit.

"I think people who sold on this issue already did so a long time ago," he added.

A widening in the 10-year interest rate swap spread over the past two months suggests that some investors may be using interest rate swaps to hedge against the possibility of a bond market sell-off and higher bond yields.

The 10-year swap spread now stands at 14 basis points , near a 7-month high of 16 basis points hit earlier this week, and up from 7 basis points in mid-May.

Treasuries took in their stride comments from Bernanke on Wednesday saying the Fed is ready to ease monetary policy further if economic growth and inflation slow much more.

The hurdles toward further monetary easing, such as a fresh asset-buying programme, seem high for now, the portfolio manager for a major Japanese bank said.

"If the economy keeps heading downwards and core inflation were to head down toward zero then in that case I think they would definitely ease policy," he said.

 

Copyright Reuters, 2011

 

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