Bonds Extend Gains on Emerging Market Worries

The entire yield curve extended its rally in the latter stages of the day as investors fled from shaky Argentine assets.
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Remember flight to quality? It made its reappearance this afternoon.

Treasuries, already in the midst of a rally, rose on the back of renewed wariness of emerging markets debt, most notably Argentina. Fears that the country will have to jettison its currency peg caused investors to pile into the safety of U.S. Treasuries.

Today was also expiration of options on the June bond futures contract, and that spurred some action in the futures market during the day, traders said.

The 30-year Treasury was lately up 28/32 to 92 23/32. The yield on the benchmark bond fell 7 basis points to 5.76%.

The entire yield curve extended its rally in the latter stages of the day as investors fled from shaky Argentine assets. The reawakening of some global worries caused investors to take profits on domestic corporate debt, which since October had outperformed the Treasury market. The yield spread between corporate bonds and Treasury bonds widened by about 2 to 5 basis points today as investors sold that debt for more liquid Treasuries, according to

Moody's Investors Service

.

"At the moment, the market is just pretty jittery," said Kim Rupert, senior economist at

Standard & Poor's MMS

. "It's not clear that Argentina is going to do anything near-term. A lot of factors played into the market today, but the erosion of a lot of the

foreign bonds contributed to the renewed flight to quality."

Latin American currencies have been under pressure because of rumors that Argentina will devalue the peso and allow its currency to float, much like Brazil did recently. Government officials shot down the rumor, but today the country's labor minister,

Erman Gonzalez

, resigned over the huge pension payments he was receiving. Hedge fund manager and financier

George Soros

today said the Argentine peso is overvalued, adding insult to injury.

The yield spread between 10-year U.S. Treasuries and Argentine 10-year global bonds has widened to 670 basis points from 550 basis points in the last two weeks, but today was the first day the turmoil in Argentina had a positive effect on Treasury prices.

"Some people think the developing problems in Argentina might lead to some flare-up in the global financial arena," said one trader. "People might be thinking that all the other spreads will undergo a reversal."

Rumors that Russian head of state

Boris Yeltsin

had died (the rumor du jour now that

Treasury Secretary Robert Rubin

has resigned) reportedly buoyed the market, although four sources interviewed today did not site that as a contributing factor to today's rally.

Options on June bond futures expired today, which added to the rally in the futures pits. The June futures contract closed at 118 19/32 today.

Those who had sold call options with a strike price of 119 and 120 were buyers of futures today. This was done to hedge the risk that the June bond contract would eventually rise above those levels. There were a lot of these people out there (open interest in 119 and 120 calls totaled about 60,000 options yesterday -- overall daily volume is around 135,000), and as futures continued to rally, they were getting nervous, so they hedged their risk. "That's what pushed the market to the north side," said a trader at a primary dealer.