By Deborah Finestone and Elizabeth Stanton
Aug. 20 (Bloomberg) -- Yields on U.S. Treasury bills fell the most in two decades on demand for the safest securities amid concern over a widening credit crunch.
Bill yields have fallen five straight days as money market funds dumped asset-backed commercial paper in favor of the shortest-maturity government debt. Three-month yields dropped the most since the stock market crash of 1987 and more than in the wake of the Sept. 11, 2001, terror attacks in the U.S, as funds shunned assets that may be linked to a weakening mortgage market.
``The market is totally, absolutely, completely in fear mode,'' said John Jansen, who sells Treasuries at CastleOak Securities LP in New York. ``People are afraid that lots and lots of mortgage paper and mortgage paper derivatives of all sorts is completely opaque and they can't price it.''
The three-month Treasury bill yield fell 0.66 percentage point to 3.09 percent as of 5:06 p.m. in New York. It's the most since Oct. 20, 1987, when the yield fell 85 basis points on the day the stock market crashed, and eclipses the drop of 39 basis points on Sept. 13, 2001, the day the Treasury market reopened after the attacks. The yield has fallen from 4.69 percent on Aug. 13. The bills yielded about 7 percent in mid-October 1987 and 3.2 percent in the days before the September 2001 attacks.
``I've never seen it like this before,'' said Jim Galluzzo, who began trading short-maturity Treasuries 20 years ago and now trades bills at RBS Greenwich Capital in Greenwich, Connecticut. ``Bills right now are trading like dot-coms.''
`Get Into Treasuries'
The flight to government debt helped the U.S. Treasury sell $21 billion in three-month bills today at a high discount rate of 2.85 percent, the lowest since 2.8 percent on May 16, 2005.
Investors fled even money market funds, considered among the safest instruments, on concern that the funds, which hold $2.5 trillion, have invested in risky collateralized debt obligations backed by subprime mortgage loans.
``We had clients asking to be pulled out of money market funds and wanting to get into Treasuries,'' said Henley Smith, fixed-income manager in New York at Castleton Partners, which oversees about $150 million in bonds. ``People are buying T-bills because you know exactly what's in it.''
Institutional investors added $39.7 billion from Aug. 14 to Aug. 17 to money market funds holding primarily government securities, a 12 percent increase, according to Connie Bugbee, managing editor of the Money Fund Report newsletter in Westborough, Massachusetts. Assets in funds that may also hold commercial paper, certificates of deposit and floating-rate notes fell 2 percent, or $24.5 billion, in the same period.
TED Spread
Three-month Treasury bill yields have fallen to 2.40 percentage points less than the London interbank offered rate, from 1.74 percentage points on Aug. 17. The ``TED'' spread, as it is known, is larger than after the 1987 crash. TED originally stood for Treasury-Eurodollar.
The Federal Reserve Bank of New York said in a statement it won't re-invest the $5 billion of Treasury bill holdings maturing on Aug. 23 through its System Open Market Account to give it ``greater flexibility'' to manage reserves. It is the first time the Fed redeemed the bills since the 2001 terrorist attacks.
The move shows the Fed expects banks to borrow that much at the Fed's discount window, compared with an average $187 million borrowed daily in the past year, said Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co.
The yield on the benchmark two-year note fell 10 basis points to 4.08 percent. The price of the 4 5/8 percent security due in July 2009 rose about 1/8, or $1.25 per $1,000 face amount, to 100 31/32 .
Slower Economy
More than half of the 21 primary government security dealers that trade with the Fed now expect the central bank to cut its target interest rate by next month from the current level of 5.25 percent.
``The Fed is going to lower the funds rate, it's a question of when,'' said Thomas Tierney, head of U.S. Treasury trading at Citigroup Global Markets Inc. in New York. ``Credit's gotten tighter, and it's going to slow the economy.''
Interest-rate futures traders see a 100 percent chance the fed will lower its overnight lending rate between banks by its next meeting on Sept. 18. Seventy percent of those bets are for rates to drop to 4.75 percent, while the balance is for a cut to 5 percent.
The Fed on Aug. 17 cut the rate it charges banks for direct loans to banks by 0.5 percentage point to 5.75 percent. It was the first reduction in borrowing costs between scheduled meetings since 2001. The central bank said in a statement that risks to the economy have risen ``appreciably.''
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