Market turmoil sends investors fleeing into Treasuries

Investors stampeded into US government debt yesterday, viewing it as the only safe haven from a new round of losses in the rest of the credit markets and another plunge by stock markets around the world.

Unprecedented demand sent interest rates on a whole range of US Treasuries to record low levels, in a flight to quality that surpassed even the effects of the mid-September panic.

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By contrast, corporate bonds, mortgage securities and other debt instruments continued to plunge in value, amid growing concerns that a global recession will lead to a new wave of defaults and losses.

The Dow Jones Industrial Average, the main US stock market measure, sold off heavily in the closing hour of trading, ending down 5.6 per cent at 7,552.29, on top of a 5.1 per cent fall on Wednesday.

The wider S&P 500 fell to its worst level since 1997, plunging 6.7 per cent to 752.44.

Earlier, the UK's FTSE 100 had closed off 130.69 points, or 3.3 per cent, at 3,874.99.

"Downside risks predominate and things are becoming increasingly scary," said John Lonski, senior US economist at Moody's Investors Services.

"It behoves Washington to take forceful action with fiscal stimulus for the economy, because the situation is graver by the day and there are dreadful implications for consumer spending."

Traders expressed astonishment at the moves in US Treasuries, which were the only major assets deemed safe enough to touch yesterday.

Government debt that matures in two, five, 10 and 30 years all had yields not seen since the US Treasury began regular issuance of such debt five decades ago. Last night, the benchmark 10-year Treasury had an interest rate below 3 per cent for the first time.

A three-month Treasury bill traded with a yield of less than zero for much of the day. This seems to signify that investors were so scared that they were willing to accept no return at all on their funds, just for the peace of mind of having the backing of the US government.

The threat of a deep recession had made other investments look too risky. Corporate bond spreads – that is, the extra yield that corporate bonds provide compared with US Treasuries – were at their highest level ever yesterday. The cost of insuring corporate debt in the credit-default swap market also blew out to another new high.

One of the latest areas of concern is the market for securities backed by commercial mortgages, which yesterday continued its recent sharp falls.

In a broad piece of research, Moody's said it would likely downgrade many individual commercial mortgage-backed securities in the coming months.

The rating agency said it expects commercial property values to fall some 20-30 per cent from the peak they reached in late 2007.

The market is expected to bottom out in 2010 at the earliest. Defaults in commercial real-estate loans are expected to increase several-fold as the weak economy begins to affect rental income, it said.

The fall of longer-dated note and bond yields to five-decade lows marked a new extreme of risk aversion among investors, many of whom have not experienced such tumultuous financial market turmoil in their lifetimes.

Many analysts are now starting to worry there is at least an outside chance of a depression, not just a recession.

"You have fear in the market that you haven't had since the 1930s," said Bryan Taylor, chief economist with Global Financial Data in Los Angeles.

The sizzling demand for US government debt should at least be welcome news for the Treasury Department, which announced it will sell $36bn (£24 bn) in two-year notes on Monday and $26bn in five-year securities on Tuesday.

Meanwhile, the US government has won permission from Congress to increase the national debt to almost $11 trillion to accommodate its spending on a bailout for Wall Street, its takeover of the mortgage giants Fannie Mae and Freddie Mac and the other measures to stabilise the markets.