Treasury buying ramps up as inflation worries ease

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NEW YORK (AP) -- The drop in oil prices isn't just helping people with fuel bills - it's also playing a role in luring them to Treasurys and assuaging fears that the government's financial bailout plan will end up hurting the bond market.

Many investors have been concerned that the bailout effort - which will be financed by selling billions of dollars in Treasury bonds - will cause prices to fall and yields to soar because of the huge increase in supply that could drive inflation higher. But with commodities and other prices falling precipitously in anticipation of a sharply weaker economy, those inflation anxieties are abating.

The 2-year note's yield dropped Wednesday below 1.20 percent for the first time since June 2003; low yields suggest high demand. Meanwhile, an auction of $20 billion in 10-year notes saw $44 billion in bids - above the average of about $26 billion for all 10-year auctions this year, noted Miller Tabak & Co. analyst Tony Crescenzi.

Some market measures have been showing that the economy could actually be headed for a deflationary environment, analysts say. Bonds are more attractive during deflation, because their fixed returns rise in value; conversely, they lose value when inflation is high.

"You have these deflationary forces that are far greater than the $1 trillion in new paper (the Treasury is) going to be bringing," said Tom di Galoma, head of Treasurys trading at Jefferies & Co. "Deflation is very real."

Among those forces, Di Galoma said, are falling real estate prices, as well as the sharp pullback in energy prices. Crude oil fell $3.50, or nearly 6 percent, to finish at $56.16 a barrel on the New York Mercantile Exchange - the lowest closing price since January 2007, and down 60 percent since record highs reached in July.

In Wednesday's Treasury market, the 2-year note rose 5/32 to 100 20/32 and yielded 1.18 percent, down from 1.28 percent Monday; the government bond market was closed Tuesday for Veterans Day. The 10-year note rose 24/32 to 102 23/32 and yielded 3.67 percent, down from 3.76 percent. The 30-year bond rose 17/32 to 105 18/32 and yielded 4.17 percent, down from 4.21 percent.

Falling bond yields are good for borrowers - many fixed-rate mortgages are tied to long-term Treasurys. Low yields are a negative, however, for people hoping to save money and keep their investments in safe assets like government debt.

Short-term Treasurys saw elevated demand on Wednesday, too, as more investors fled commodities and Wall Street, where the Dow Jones industrials fell more than 410 points. The yield on the three-month Treasury bill - considered one of the safest assets around - fell to 0.13 percent, down from 0.25 percent Monday and its lowest level since Oct. 15. The discount rate was 0.14 percent.

Although the market for Treasury bills showed how anxious investors are - many are willing to take the slimmest of returns in order to preserve their principal - there are signs that the credit markets continue to ease.

The Federal Reserve auctioned $150 billion in 17-day credit to banks earlier this week, but banks took only $12.6 billion - indicating that private financial institutions' needs for cash are being met by the U.S. central bank.

Bank-to-bank lending rates have been falling over the past several weeks after governments around the world pumped money into the global financial system.

The London interbank offered rate, or Libor, for three-month dollar loans fell to 2.13 percent on Wednesday from nearly 2.18 percent on Tuesday. This rate not only indicates banks' willingness to make loans to one another, but it also determines some key consumer loan rates, including those on adjustable-rate mortgages.

About a month ago, the three-month dollar Libor rose as high as 4.82 percent. At that time, fears about bank failures were peaking in the aftermath of Lehman Brothers Holdings Inc.'s mid-September bankruptcy.

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