Subprime Contagion May Claim 10-Year Treasuries Next

The U.S. housing slowdown that propelled 10-year Treasuries to their biggest gains since 2002 may soon make the same securities laggards in the government bond market.

The notes returned 9.6 percent since mid-June as investors sought a haven from credit market losses caused by subprime mortgages, Merrill Lynch & Co. index data show. Sales of bonds backed by housing loans have dropped 20 percent this year as home purchases declined, according to Citigroup Inc., reducing the need for longer-maturity Treasuries as a hedge.

Fund managers may ``no longer buy the 10-year Treasury'' to protect their holdings, said Ajay Rajadhyaksha, head of interest rate strategy in New York at Barclays Capital Inc., one of 21 primary dealers of U.S. government securities obligated to bid at Treasury auctions.

The mortgage market's influence over Treasuries has increased as the amount of home loans quadrupled to $10.9 trillion since 2001, according to the Mortgage Bankers Association in Washington. More than $6 trillion of securities backed by home loans are outstanding, compared with $4.5 trillion of U.S. government debt securities, data compiled by the Treasury show.

About $100 billion of 10-year Treasuries trade every week among the primary dealers, according to Federal Reserve data. Hedging by owners of housing-related bonds surges to as much as 45 percent of that amount when yields drop by about a quarter percentage point, Rajadhyaksha said.
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