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BL: Two-Year Treasury Notes Post Biggest Weekly Decline Since 2001

By Deborah Finestone and Daniel Kruger

April 18 (Bloomberg) -- U.S. two-year Treasury notes posted their biggest weekly decline since 2001 as better-than-forecast revenue from Citigroup Inc. spurred gains in stocks and decreased demand for government debt.

Traders stepped up bets the Federal Reserve will cut its benchmark interest rate by just a quarter-percentage point April 30 after policy makers signaled this week they're hesitant to drop rates further. Two-year note yields reached the highest since January, surpassing the Fed's target for the overnight interbank lending rate for the first time since June 2006.

``People are looking around at other opportunities and Treasuries have suffered from that,'' said Thomas Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment-banking arm of Canada's biggest lender. ``The market is trying to normalize as it moves into a period when it believes the Fed won't be moving as quickly.''

Two-year yields rose 4 basis points today, or 0.04 percentage point, to 2.15 percent as of 4:05 p.m. in New York, and touched 2.26 percent, the highest since Jan. 30, according to broker BGCantor Market Data. The yield increased 40 basis points this week, the most since November 2001. The price of the 1 3/4 percent security due March 2010 fell 1/16 today, or 63 cents per $1,000 face amount, to 99 8/32.

The benchmark 10-year note yield was little changed at 3.73 percent, after earlier touching 3.85 percent, the highest since Feb. 28. It rose 26 basis points this week, the most since 2004.

Libor Jumps

Yields on two-year notes also rose as the rate to borrow dollars in the London interbank market surged the most since August in response to a threat by the British Bankers' Association to ban members that deliberately understate borrowing costs.

Citigroup, the biggest U.S. bank by assets, reported a first-quarter net loss of $5.11 billion, less than analysts' most pessimistic estimates. Revenue fell 48 percent to $13.2 billion, compared with the $11.1 billion average estimate in a Bloomberg survey. The Standard & Poor's 500 Index gained a fourth straight day, by 1.8 percent.

The cost of borrowing in dollars for three months rose to the highest since March 11. The Libor rate for dollars climbed 9 basis points to 2.91 percent, the BBA said today. The two-day climb of 17 basis points is the biggest since August.

The drop in two-year notes ``is related to the issue with Libor, and it's forcing down the short end of the curve,'' said Theodore Ake, head of U.S. Treasury trading at Mizuho Securities USA Inc. in New York. ``People are really worried about the implications of the Libor mess; unlike the previous times when they didn't know what to do and bought two-year notes, this time they're selling two-year notes and trying to get into cash.''

Just a Quarter-Point

Futures on the Chicago Board of Trade show a 100 percent chance the Fed will cut its target rate by just a quarter-point to 2 percent this month. A week ago, traders saw a 54 percent chance of a quarter-point cut, with the rest of the bets on a half-point cut, futures show.

The Fed has slashed its benchmark rate by 3 percentage points since September to 2.25 percent to avert a recession and spur lending.

Industrial production rose 0.3 percent last month, after a 0.7 percent drop in February, the Fed said this week. Economists had forecast a drop of 0.1 percent. A separate Fed report this week showed New York manufacturing unexpectedly grew in April.

The decline in two-year notes pushed their yields to within 158 basis points of those on 10-year notes, the smallest difference since Feb. 4.

Auctions Ahead

Two-year debt also fell before a government auction next week that may be the biggest on record for the maturity.

The Treasury's two-year note sale on April 23 may tally $30 billion, according to Jersey City, New Jersey-based Wrightson ICAP, which specializes in U.S. government finance and is a unit of the world's biggest inter-bank broker. That would be the most ever sold for the maturity, according to the Treasury. The government may sell $20 billion of five-year notes the following day, which would be the most since 2003, according to Wrightson. The government announces the amounts April 21.

Philadelphia Fed President Charles Plosser said the central bank's short-term rate is already low enough to support growth.

The Fed's actions have ``resulted in an accommodative level of real interest rates that should support the market forces that will bring economic growth back toward its long-term trend,'' Plosser said in Philadelphia.

`Inflating' the Economy

Dallas Fed President Richard Fisher yesterday said he's hesitant to lower borrowing costs further and warned against ``inflating'' the economy out of the credit crisis in a speech in Chicago.

Some investors may find value in two-year notes because increasing stress in the credit market may further erode economic growth, William O'Donnell, head of U.S. government bond strategy in Stamford, Connecticut, at UBS Securities LLC wrote in a research note today.

``We believe short Treasury securities have real value here'' with two-year note yields close to a ``major support'' level of about 2.15 percent, he said.

To contact the reporter on this story: Deborah Finestone in New York at [e-mail]; Daniel Kruger in New York at [e-mail]
Last Updated: April 18, 2008 16:10 EDT