Two and 30-yr yields hit new lows

By Kirsten Donovan

LONDON (Reuters) - Two-year U.S. Treasury yields hit a record low on Thursday on market expectations the Federal Reserve will cut interest rates next month in an attempt to shore up the faltering economy and as stock markets slid to multi-year lows.

Longer-dated bonds also rallied, with 30-year yields hitting their lowest since the early 1960s as signs of a sharp slowdown in inflation encouraged investors to move in to the paper.

Federal Reserve officials pared their outlook for economic growth through 2009 to minimal levels and are ready to cut interest rates further, minutes of the Fed's October 28-29 meeting released on Wednesday showed.

The Fed expects U.S. growth to contract in the second half of 2008 and the first half of 2009.

Worries over the economy were compounded by credit jitters fueled by mounting uncertainty over the fate of the struggling U.S. auto industry, while fears of a rapid deterioration in commercial real estate -- spreads or risk premiums on commercial mortgage-backed securities (CMBS) ballooned to record wides on Wednesday -- threatened more write-downs for the banking sector.

Questions over the survival prospects of U.S. banking giant Citigroup, which sent its shares tumbling 23 percent to a 13-year low, also weighed on the banking sector.

"Risk aversion is on the rise, stocks are getting pummeled, credit spreads are moving wider and investors are looking for a place of safety, and that's bonds," noted Nick Stamenkovic, a bond strategist at RIA Capital Markets.

"Consequently we've seen yields fall across the curve, particularly at the long-end as investors search for yield and extend duration."

U.S. interest rate futures show investors see a roughly 80 percent chance of the Fed slashing interest rates by 50 basis points to 0.50 percent at a policy meeting in December, which would be the lowest since the 1950s.

The two-year Treasury note yield hit a record low of 1.060 percent according to Reuters data. After trimming gains, the paper was last yielding 1.0887 percent.

Benchmark 10-year Treasury yields were 7.4 basis points lower at 3.266 percent, while T-note futures rose 45/64 to 119-61/64. The growing uncertainty over whether U.S. automakers, including General Motors (GM.N), will win emergency government loans lent support to three-month Treasury bills, with the yield falling to 0.056 percent, the lowest since the collapse of U.S. investment bank Lehman Brothers in September. Recent evidence of evaporating inflation boosted 30-year bonds with the yield sliding as low as 3.836 percent, the lowest late session level since 1961, according to Global Financial Data.

"The curve is bull-flattening, the long end is outperforming the short end with investors moving further down the curve as the Fed is clearly running out of ammunition," said RIA's Stamenkovich.

"Certainly we're near a disinflationary environment and deflation can't be ruled out."

In money markets interbank lending rates for three-month dollar funds edged up slightly but were in a tight range on Thursday, while the two-year interest rate dollar swap spread narrowed further, Reuters data showed.

In early London trading, three-month dollar deposit rates were indicated in a 2.22-3.05 percent range, compared with a 2.12-2.9 percent range early on Wednesday.

London interbank offered rates for three-month dollars (Libor) have been easing this week after edging higher toward the end of last week.