Bonds soar, dollar free falls
Unnerved investors flee to bond market as government takeover of AIG renews fears that the worst is not over. Dollar down sharply as Treasury yields continue to slide.
NEW YORK (CNNMoney.com) -- So how did investors in the Treasury and currency markets react Wednesday to Wall Street's continued meltdown?
Government bonds bounced back strongly, sending the benchmark 10-year Treasury yield back down near the five-year low it set Tuesday morning. The yield on the three-month bill briefly sank to a level not seen in 68 years.
The dollar went into a virtual tailspin as foreign investors were concerned about buying U.S. debt and assets if the government needs to dish out even more cash for another bailout.
After government bailouts of Bear Stearns earlier this year and Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) last week, the government bailed out the collapsing insurance firm American International Group (AIG, Fortune 500) Tuesday night, signaling to Wall Street that the embattled financial markets still have a long road to recovery.
Stocks tanked Wednesday, sending investors fleeing to the perceived security of the U.S. Treasury bonds market even as yields plummeted.
"People tend to believe that the only risk-free investment is Treasurys, but the market is totally collapsing," said Antonio Sousa, senior currency strategist at Forex Capital Markets.
The benchmark 10-year note rose 7/32 to 104 30/32, and its yield slid to 3.41% from 3.43% late Friday. Bond prices and yields move in opposite directions.
Before rising later in the day Wednesday, the yield on the 3-month Treasury bill fell to 0%, the first time the 3-month yield fell to 0% or below since January 1940, according to Sousa.
Tuesday, the yield on the 10-year note fell to 3.25% at one point, the lowest level the benchmark yield has seen since June 2003.
The 30-year bond surged 11/32 to 107 9/32, and its yield slid to 4.08% from 4.09%. The 2-year note gained 10/32 to 101 13/32, and its yield fell to 1.64% from 1.79%.
Treasurys soared Monday and early Tuesday on continued nervousness on Wall Street but then sank Tuesday afternoon after the Federal Reserve decided to hold interest rates steady at 2%.
The dollar fell sharply Wednesday as Treasury yields collapsed, despite getting a boost from the Fed's rate-holding decision Tuesday.
"Foreign governments move trillions of dollars into Treasurys, but now they have yields that don't make up for inflation," Sousa said. "Everyone is worried about systemic risk, so they are investing in countries that offer higher yields."
The 15-nation euro cost $1.4349, up from $1.4120 in the previous session. That's a whopping 1.6% drop - the dollar usually trades in a range of just tenths of a percent on a daily basis. The British pound bought $1.8211, up from $1.7831 Tuesday - a 2.1% drop.
Against the Japanese yen, the dollar fell to ¥104.80, down 0.8% from ¥105.65.
Wall Street's woes also weighed heavily on the dollar. Investors feared that the rising number of government bailouts will force the government to print more dollars, devaluing the U.S. currency.
"The market is concerned that the Fed will intervene if there is a new AIG," said Sousa. "Investors are worried that the Fed will run out of cash." 
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