Treasuries Rally as European Discord Threatens Greece Rescue; Swaps Surge

Treasuries gained, pushing two-year note yields down the most since April, after European Union talks on achieving a second bailout for Greece to prevent the first euro-area default stalled.

Yields on benchmark 10-year notes dropped below 3 percent as investors sought a refuge in U.S. government debt. The cost of insuring against default on Greek, Irish and Portuguese government debt surged to records as the opposition in Greece told Prime Minister George Papandreou to resign, allies turned against him and police deployed tear gas to break up anti- government protests in Athens.

“In the near term, bonds are likely to rally,” said Ajay Rajadhyaksha, head of U.S. fixed-income strategy in New York at Barclays Plc, one of the 20 primary dealers that trade directly with the Federal Reserve. “Political risk in the euro zone cannot be underestimated, and that will have significant impact on the debt situation there. You cannot ignore the possibility of contagion.”

Yields on two-year notes dropped six basis points, or 0.06 percentage point, to 0.38 percent at 5:00 p.m. in New York, according to Bloomberg Bond Trader prices. The 0.5 percent security due in May 2013 rose 1/8, or $1.25 per $1,000 face amount, to 100 7/32.

The decrease in the two-year note yields was the biggest since April 15. Ten-year note yields fell 13 basis points to 2.97 percent, erasing yesterday’s gain, which was the most on a closing basis since Jan. 5. The yields rose yesterday above 3.10 percent for the first time this month.

‘Reversing Course’

“Treasuries are responding to Greece news,” said Russ Certo, a managing director and head of rates trading at Gleacher & Co. in New York. “We’ve sustained new highs and are sort of reversing course on the market. People have considered a variety of outcomes for the euro.”

The euro declined as much as 2 percent, the most since May 5, while the Standard & Poor’s 500 Index fell 1.7 percent and crude oil tumbled as much as 5.4 percent to $94.01 a barrel in New York.

Greek Prime Minister George Papandreou said he will make changes to his Cabinet tomorrow and will then immediately seek a vote of confidence in Parliament. Papandreou spoke in comments televised live on state-run NET TV. Police used teargas to disperse protesters encircling the Parliament House as 20,000 people rallied against Papandreou’s additional wage cuts and tax increases.

EU Talks

An emergency session of finance ministers in Brussels failed yesterday to reconcile a German-led push for bondholders to shoulder part of the cost of a new Greek aid package with European Central Bank warnings backed by France that the move might constitute the euro area’s first sovereign default.

Greece credit-default swaps soared 118 basis points to 1,723, Portugal climbed 22 to 776 and Ireland rose 22 to 750, according to CMA prices in London. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments rose 10 basis points to 218.5.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase signals deteriorating perceptions of credit quality.

Treasuries rose earlier as manufacturing in the New York region shrank in June, with the New York Fed’s general economic index falling to negative 7.8 from 11.9. Readings greater than zero signal expansion in the Empire State Index, which covers New York, northern New Jersey and southern Connecticut.

‘Weakened faster’

“Economic conditions have weakened faster than expectations,” said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets in New York. “It’s another factor restricting global growth and putting stress on the financial system.” The unit of Royal Bank of Canada is a primary dealer.

Output at U.S. factories, mines and utilities rose 0.1 percent in May after no change in the prior month, figures from the Fed showed. The median forecast of economists in a Bloomberg News survey was for an increase of 0.2 percent.

The Fed purchased $4.7 billion of Treasuries maturing from January 2017 to May 2018 today as part of its $600 billion second round of quantitative easing expiring this month.

Consumer Prices

Bonds briefly pared gains after the U.S. Labor Department reported that the consumer-price index increased more than forecast, rising 0.2 percent in May after a 0.4 percent advance in the previous month. The median forecast of 79 economists in a Bloomberg News survey was for a 0.1 percent increase.

Treasuries tumbled yesterday on evidence of resilience in retail sales and an increase in wholesale prices that was bigger than projected.

Foreign holdings of Treasuries rose in April for a 24th month, increasing by $9.9 billion, or 0.2 percent, to $4.49 trillion, the U.S. Treasury Department reported today. Overseas investors held 49 percent of the $9.14 trillion in outstanding public Treasury debt.

“Foreign investors have been active out the curve and purchasing securities during the period of time covered in this data, and I would expect to see a follow-through,” said Chris Ahrens, head interest-rate strategist in Stamford, Connecticut, at UBS AG, a primary dealer.

China’s holdings of U.S. debt increased in April for the first time in six months, rising 0.7 percent to $1.15 trillion. Holdings of Treasury bills fell to $3.9 billion, its smallest position in short-term debt since April 2004. China is the biggest foreign investor in America’s debt. Japan’s holdings fell for the first time since May 2010, decreasing $1 billion to $907 billion.

To contact the reporters on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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