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US Treasuries surge in anticipation of another rate cut

"Fed rate cuts, weakness in manufacturing -- people are running those scenarios and it's making them depressed, which is making them buy Treasuries."

John Poole, a manager at Mellon Private Asset Management

US Treasuries surged, sending the yield on the most widely traded two-year note to a record low, after Goldman, Sachs & Co said the Federal Reserve will cut interest rates to bolster a faltering economic recovery.

The 2 1/4 percent note maturing in July 2004, one of the securities most sensitive to Fed rate changes, gained more than 1/8, or US$1.25 per US$1,000 face amount, to 100 15/32 at 5:15pm Friday as Goldman said the Fed will cut the overnight interbank lending rate as much as 1 percentage point by year-end to 0.75 percent.

The note's yield fell 12 basis points to 2 percent, its lowest since the government began regular sales of the security in the 1970s. It has dropped 1.37 percentage points in the past 11 weeks.

"Fed rate cuts, weakness in manufacturing -- people are running those scenarios and it's making them depressed, which is making them buy Treasuries," said John Poole, who helps manage US$10 billion at Mellon Private Asset Management in Boston.

The 4 7/8 percent note due in 2012 rose 13/16 to 104 9/16, trimming its yield 10 basis points to an eight-month low of 4.29 percent. A basis point equals 0.01 percentage point.

The 10-year note lagged gains in the two-year note as some analysts said a rate cut after 11 reductions last year may spark faster inflation, eroding the value of securities with longer maturities. The difference in yields between two and 10-year notes widened 2 basis points to 2.29 percentage points. The gap is the widest since January 1993, months after the Fed finished a series of rate cuts.

Ten-year notes also lagged gains in two-year notes as investors anticipated the government's sale next week of a record US$18 billion in 10-year notes and $22 billion in five-year notes.

The Treasury is swelling the supply of securities to finance the first budget deficit since 1997. The five-year note sale equals the size of a record sale last quarter.

The yield gap between two and 10-year notes is within 40 basis points of its peak in 1992 of 2.68 percentage points. "You can certainly surpass that high" within a few months, said Richard Gilhooly, a government bond strategist at BNP Paribas.

A government report today added to evidence the recovery is slowing. The economy generated 6,000 new jobs last month, a fraction of the 60,000 forecast by economists, leaving the unemployment rate at 5.9 percent.

Stocks fell, boosting the appeal of Treasuries' fixed-rate payments. The S&P 500 dropped 2.3 percent, extending its losses this year to 25 percent amid corporate accounting scandals and concern profit growth will be sluggish. The tumble in stocks has weakened consumer confidence. Economists say that may lead to a decline in consumer spending, which accounts for two-thirds of demand in the economy.

Reports earlier this week showed the US economy expanded at less than half the rate forecast in the second quarter and that manufacturing growth slowed in July.

The economy grew 1.1 percent in the second quarter, cooling from a 5 percent annual rate of expansion in the January-to-March period. The Institute for Supply Management said its factory index fell to 50.5 in July from 56.2 in June.
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