Bonds fall on shifting sentiment

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NEW  YORK (CNNMoney.com) -- Treasurys fell Monday as investors' fears over a Citigroup collapse were allayed, and as a fresh supply of debt inundated the market.

Investors had feared that the bank's collapse could leave the financial market in tatters, just as Lehman Brothers' bankruptcy did in mid-September.

But the Treasury and FDIC said Sunday that they will guarantee losses on more than $300 billion of Citi's (C, Fortune 500) troubled assets, and the Treasury will make another $20 billion investment in the bank - on top of a previous $25 billion capital injection.

The news sent investors rushing to equities on Monday, which helped push Treasurys lower as money shifted out of the lower-yielding investments.

"With stocks higher following the Citigroup bailout, some of the safe haven flows are exiting Treasury and getting back into riskier asserts such as stocks," said Kim Rupert, fixed income analyst with Action economics.

Investors were also heartened by President-elect Barack Obama's announcement of his economic advisory team. Obama picked New York Fed President Timothy Geithner to be the next Treasury secretary and former Treasury Secretary Lawrence Summers as his chief economic advisor.

Treasury supply jolt: Treasury prices also tumbled as a large amount of debt entered the market. The Treasury auctioned off $36 billion of 2-year notes Monday and was set to auction another $26 billion of 5-year notes Tuesday.

In addition, the government sold $28 billion worth of 3-month bills Monday at a rate of 0.15% and another $28 billion worth of 6-month bills at a discount rate of 0.49%.

The rate that the 3-month bills were sold at Monday matched the low set last week for that offering, at least as far back as the Treasury has electronic records through 1980, according to McKayla Braden, senior advisor, Bureau of the Public Debt. The 0.49% discount rate that the 6-month Treasury was sold at was the lowest discount rate since at least as far back as 1980, according to the electronic Treasury records that go back for the past 28 years, said Braden.

The yield on the 6-month bill set a new historic low of 0.48% Monday, after touching a low of 0.41% earlier in the session. The yield on the 6-month bill was the lowest yield on the bill since 1982, when the government began keeping records for this information. The yield closed at a previous record low of 0.52% on Thursday.

Despite the Treasury's expectation of $920 billion in auctions of government debt to finance its various financial rescue measures, demand for bonds has remained strong throughout the credit crisis.

The benchmark 10-year note fell 1-3/32 to 103-20/32, and its yield rallied to 3.32% from 3.20% late Friday.

The 2-year note fell 7/32 to 100-18/32, and its yield rose to 1.22% from 1.10%.

The benchmark yield curve, the difference between the 2-year and the 10-year yield, increased slightly to 2.11 percentage points from 2.10 points. The yield curve is a key measure of investor sentiment, with a higher curve generally indicating a weaker economic environment.

The 30-year bond dropped 1-23/32 to 112-25/32, and its yield rose to 3.78% from 3.68%. Before last week, the yield on the 30-year bond had only once before fallen below 4% and that was in late October.

Meanwhile, the yield on the 3-month bill rose to 0.03% before retreating again to 0.02%, even with Friday. The 3-month yield is still near lows not seen since the height of the financial crisis, when it hit 0%.

The yield on the 3-month Treasury bill is closely watched as an immediate reading on investor confidence, with a lower yield indicating less optimism.

Even as Treasurys fell, lending rates still rose slightly. The 3-month Libor rate rose slightly Monday for the second-straight session to 2.17% from 2.16%, according to Dow Jones. The overnight Libor rate rose for the fourth-straight day to 0.8% from 0.7%, according to Bloomberg.

Libor, the London Interbank Offered Rate, is a daily average of interbank lending rates and a key barometer of liquidity in the credit market. More than $350 trillion in assets are tied to Libor.

Lending rates have been little changed in recent weeks. "The 3-month Libor rate is hovering just under 2.20% and it seems to have stabilized there for the last couple of weeks," said Rupert.

That rate had hit record levels at the height of the credit crisis, but as governments around the globe injected massive amounts of liquidity into financial systems worldwide, those bank-to-bank lending rates have eased.

"We are still not out of the woods, but we have made significant progress," said Rupert.

As lending rates edged higher, two gauges of banks' confidence in the credit market were mostly unchanged.

The Libor-OIS spread dipped slightly to 1.68 from Friday's 1.69 percentage points. The spread measures the difference between actual borrowing costs and the expected targeted borrowing rate from the Fed. It is used as a gauge to determine how much cash is available for lending between banks. The bigger the spread, the less cash is available for lending.

Another indicator, the TED spread, held steady at 2.15 percentage points. The TED spread measures the difference between the 3-month Libor and the 3-month Treasury bill, and is a key indicator of risk. The lower the spread, the more willing investors are to take risks.