By Cynthia Lin
Treasurys reversed some of last week's losses Monday as investors turned jittery about policy makers being able to reach deals in time to cope with Greece and the U.S.'s fiscal troubles.
Not one week ago, there was an air of optimism across financial markets about such resolutions. Ahead of the U.S. Thanksgiving holiday, investors felt Greece would eventually get its hand on another round of financial aid and that the U.S. would avoid a set of growth-destructive year-end fiscal deadlines.
But with leaders still in discussion on both sides of the Atlantic, investors started the new week on a less-optimistic note, with safe-haven Treasurys gaining at the expense of riskier stocks.
"The equity market certainly behaved last week as though the fiscal cliff issue was solved with minimal pain," said Richard Gilhooly, interest rate strategist at TD Securities. "The fact that we have no details and weekend press suggests the two sides remain far apart is starting to wear on positions."
A Wall Street Journal report Sunday said talks in Washington to avoid expiration of various spending programs and tax cuts have barely progressed, raising concerns that a deal won't be struck until the last minute.
In late-afternoon trading Monday, benchmark 10-year notes gained 9/32 in price to yield 1.663%. The 30-year bond rose 21/32 to yield 2.799%, while two-year notes inched up fractionally to yield 0.270%. Bond yields fall when prices rise.
At these levels, the rates strategy team at Bank of America-Merrill Lynch believes the market has yet to come to full realization that the U.S. economy faces less growth support from the government in the coming year. The firm sees $325 billion worth of fiscal tightening in 2013, at a time when the Federal Reserve has little firepower left in its monetary-easing tools.
Goldman Sachs similarly warned of the impending economic drag from the U.S.'s efforts to fix its finances, expecting a 1.4% hit to growth next year. But this dealer believes such a degree of fiscal tightening is already priced into the market, so an agreement in Washington would have a positive effect on the economy in terms of clearing up uncertainties about future tax and spending programs.
Goldman sees the Fed ramping up its easing efforts to offset the fiscal drag, expanding its bond-buying program next year to include $45 billion of monthly Treasury purchases. While this has a downward impact on Treasury yields, the firm says the stimulative effects it will have on the economy "is likely to prevail over time" and lead 10-year notes to yield 2.5% by the end of 2013.
For now, however, uncertainty reigns, which means a generally supportive environment for safe-haven Treasurys where selloffs are likely capped. Late Monday, top Democratic and Republican leaders of the U.S. Senate expressed frustration over fiscal-cliff negotiations. A White House report earlier in the day warned that hitting the cliff could slow real gross domestic product growth by 1.4% and weigh on consumer spending this holiday season.
In Europe, finance ministers met again in Brussels to hammer out terms to fill Greece's funding shortfall. While individual officials expressed optimism about a deal being on the horizon, a report late Monday said the International Monetary Fund wants euro-zone governments to commit to taking Greece's debt to under 120% of GDP by 2020.
U.S. Swap Spreads Widen
The U.S. two-year swap spread, which measures the difference between the two-year swap rate and two-year Treasury yield and is a main gauge of credit risks, was 0.75 basis point wider at 13.5 basis points. The 10-year swap spread was 0.25 basis point tighter at 3.75 basis points.
COUPON ISSUE PRICE CHANGE YIELD CHANGE
1/4% 2-year 99 31/32 up 0/32 0.270% -0.4BP
1/4% 3-Year 100 1/32 up 1/32 0.359% -1.1BP
3/4% 5-year 100 13/32 up 4/32 0.666% -2.2BP
1 1/4% 7-Year 101 4/32 up 6/32 1.081% -2.8BP
1 5/8% 10-year 99 21/32 up 9/32 1.663% -3.2BP
2 3/4% 30-year 99 0/32 up 21/32 2.799% -3.3BP
2-10-Yr Yield Spread: 139.3BPS v 142.1BPS
Write to Cynthia Lin at firstname.lastname@example.org