Bond buying frenzy takes a breather

NEW YORK (CNNMoney.com) -- Investors again sought the safety of the government bond market Tuesday but reversed their purchases of the shortest-dated, safest securities in a sign that investors are a bit less nervous about the freeze-up in the credit markets.

Three-month Treasury bills, which became the focus of the market and rallied Monday as investors sought the safest place they could find for their cash, sold off Tuesday. That pushed three-month yields back up to 3.58 percent, from about 3.2 percent late Monday, when yields posted the biggest drop since the stock market crash of 1987.

Video More video Conrad DeQuadros of Bear Stearns offers perspective on the Fed's decision and the reaction on Wall Street. Play video

"All of which points in the direction of things being less uncertain," said Pierre Ellis, senior economist at Decision Economics in New York, acknowledging the credit market uncertainty, which has roiled global stock markets in recent weeks. "The flight to quality may have eased ever so slightly."

Other shorter-term debt pared early gains, with the two-year note rising 3/32 to yield 4.03 percent. The five-year note rose to yield 4.26 percent. Bond prices and yields move in opposite directions.

Longer-term debt, such as the market's usual benchmark, the 10-year Treasury note, climbed 8/32, or $2.50 on a $1,000 note, to yield 4.59 percent, down from 4.65 percent late Monday. The 30-year note gained 9/32 to yield 4.94 percent, down from 4.98 percent in the previous session.

After snapping them up early in the session on renewed credit market concerns, investors turned around and sold three-month bills after Monday's big runup. Also feeding the selloff: a meeting between Senate Banking Committee Chairman Christopher Dodd, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson.

Dodd said Bernanke pledged to use all the necessary tools to calm financial markets, but said he did not pressure the central bank chief to cut interest rates.

Richmond Fed President Jeffrey Lacker maintained the hawkish tone from the central bank's most recent meeting, saying that that rate cut was not warranted unless the recent market turmoil affected the outlook for inflation or economic growth.

"Financial market volatility, in and of itself, does not require a change in the target federal funds rate, in my view. Interest rate policy needs to be guided by the outlook for real spending and inflation," Lacker, who is not a voting member of the Fed's policy-setting committee, told a business group.

The Fed left short-term rates unchanged at its Aug. 7 meeting, saying inflation remained its main concern, but tried to calm markets last week by pumping money into the financial system. The central bank then went one step further by cutting its little used discount rate - the rate the central bank charges to lend banks money - by half a point last Friday.

Speculation has run rampant on Wall Street that the Fed will soon be forced to cut its more closely watched fed funds rate, which affects rates on many consumer loans, from 5.25 percent to address the freezing up of credit.

Some investors believe the Fed would cut rates before policymakers meet again in September - and possibly again before the end of the year.

In related news, the Chinese central bank raised interest rates in an effort to stabilize inflation expectations.

In currency trading, the dollar retreated versus the yen, trading at ¥114.26, down from ¥114.96 Monday, while the euro bought $1.3465, down from $1.3485.

--from staff and wire reports