Bonds fall as investors look to stocks

ROAD TO RESCUE

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Click chart to view latest bond prices

Click chart to view latest bond prices

NEW YORK (CNNMoney.com) -- Government bonds fall Monday afternoon after stocks end lower, letting go of early gains and snapping a five-day rally.

Equities rallied nearly 11% in the past four sessions, and investors became hopeful that the stock market could be close to stabilizing.

In turn, traders have shifted out of safe but low-yielding government bonds in the past two sessions, opting instead for riskier equities that have potential for higher rewards.

Bonds have struggled in the first 2-1/2 months this year. Stocks have largely floundered on continued weak economic news, but the government has auctioned off record amounts of debt to finance its expensive economic rescue efforts.

The auctions have been successful so far this year, most recently in a $63 billion sale last week, which attracted more than enough investors to fund the debt offerings.

Still, some investors have expressed concern that demand for Treasurys, though high, will not be enough to meet the rapidly increasing supply of bonds. The Treasury expects to issue between $2.7 trillion and $4.2 trillion in bonds in the next two years.

As a result, government bonds' return to investors is down 2.69% in 2009, compared to a near-14% rise in 2008, according to a Lehman Bros. U.S. Treasury index.

The most notable of the concerned investors is Chinese Premier Wen Jiabao, who said Friday he worries that the mammoth amounts of Treasury debt his country holds will deteriorate in value as the U.S. deficit increases. China owns nearly $740 billion of U.S. debt, or nearly 7% of the $10.9 trillion of U.S. debt outstanding, according to the latest Treasury International Capital (TIC) report released Monday.

The TIC report eased some investors' concerns, as net foreign purchases of long-term Treasurys were $10.7 billion in January. The report showed that in December foreign investors had purchased a net $15 billion of U.S. debt and sold a net $25.8 billion of Treasurys in November.

Still, Treasurys still may continue to fall if the recent stock market rally continues. Though stock investors are hoping a sustained rally could mean that the worst of the recent financial market meltdown is in the past, that could lead to a new problem: diminishing support for bonds.

If investors leave the bond market, the government may have difficulty paying for its $787 billion stimulus package, $700 billion bank bailout and hundreds of billions of dollars more in financial market rescue programs.

Bond prices: In late trading, the benchmark 10-year note edged down 16/32 to 98-8/32 and its yield rose to 2.96% from 2.90% Friday. Bond prices and yields move in opposite directions.

The 30-year bond fell 1-14/32 to 95-13/32 with a yield of 3.76%, up from 3.68%.

The 2-year note edged down 3/32 to 99-24/32 and yielded 1.01%, up from 0.97%.

The 3 month bill yielded 0.23%, up from 0.21%.

Lending rates: The 3-month Libor rate fell to 1.31%, down from 1.32% on Friday, according to data on Bloomberg.com. The overnight Libor rate held steady at 0.33%.

Libor, the London Interbank Offered Rate, is a daily average of rates that 16 different banks charge each other to lend money in London.

Two credit market gauges were positive. The "TED" spread narrowed to 1.07 percentage point from 1.11 percentage points. The narrower the TED spread, the more willing investors are to take risks.

The Libor-OIS spread held steady at 1.08 percentage point the prior day. A narrower spread indicates that more cash is available for lending.