U.S. Treasury debt prices rose on Friday, halting a two-day decline, as nervous investors dumped stocks and shifted into government bonds as fears of the subprime mortgage problems reverberated through financial markets.
A classic safe-haven bid drove the two-year Treasury's yield to its biggest weekly fall in two months. Bond yields and prices move inversely. When riskier assets such as stocks and corporate bonds sell off, investors often seek refuge in less volatile short-dated Treasuries.
This is a risk aversion trade, said Matthew Moore, economic strategist with Bank of America Securities in New York. The bounce in Treasury prices is just these mortgage fears continuing to play out, he said.
This week, problems at two hedge funds managed by Bear Stearns renewed worries about the spillover effect from ongoing problems in the subprime mortgage sector.
Bear Stearns Cos. Inc. on Friday said it would provide up to $3.2 billion in financing for a struggling hedge fund it manages, but sources said a second fund is still working out a restructuring plan with creditors.
The bailout spurred investors to sell shares of investment and commercial banks and buy safe haven Treasuries. Major stock indexes fell about 1 percent on the day.
Two-year Treasury notes were up 3/32 in price for a 4.92 percent yield, versus 4.98 percent late on Thursday.
The hedge fund news is probably driving people a little bit away from equity, said Don Kowalchik, debt strategist at A.G. Edwards & Sons. Basically it looks like a flight to quality bid, he said.
Swap spreads -- a gauge of investors risk aversion -- narrowed slightly on Friday, but at 62 basis points, the 10-year swap spread was still close to its widest levels since 2003.
Longer-dated government debt prices rallied, in contrast to the previous two sessions when they lagged shorter-dated issues amid concerns over elevated price pressures globally.
Benchmark 10-year Treasury notes were up 11/32 in price for a yield of 5.14 percent, down from 5.19 percent late Thursday. The benchmark security was on track for its first week of price gains after six consecutive weeks of losses.
The 10-year note yield's gap above those of 2-year notes widened to about 22 basis points, its steepest level since October 2005.
But investors were turning cautious ahead of the Federal Reserve's policy-setting meeting next week. Wall Street widely expects the Fed to leave the key federal funds rate unchanged at 5.25 percent, but signs of reviving economic growth are expected to keep inflation the predominant issue for policy-makers.
Some market participants cited signs that Asian accounts are gradually paring back their Treasuries purchases as a persistent weight on long-dated Treasury prices that will likely push the 10-year yield above 5.25 percent, back up toward a five-year high of 5.33 percent hit last week.
The 5.25 percent number is still the bias for the near term, said Tom Atteberry, fixed income fund manager of First Pacific Advisors. If I have 5.25 percent funds rate why wouldn't I want to see the 10-year at 5.25 percent?, Atteberry said, citing a gradual ebbing of Asian buying of U.S. government bonds.
The 30-year bond rose 21/32 in price for a yield of 5.26 percent, versus 5.31 percent late on Thursday.
(Burton Frierson contributed to this report)