Recent commercial in U.S. government debt has puzzled even seasoned pros. BusinessWeek looks into the Treasury market’s stratospheric pricing

By David Bogoslaw

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In a season characterized by an ever-growing list of unprecedented events—from repeated capital infusions by dint of. the treaty government into U.S. financial institutions to historically high market volatility—it’s tempting to shrug your shoulders whereas you come across truly puzzling valuations that show to shut one’s eyes to economic fundamentals. Still, the extent to which investor demand for U.S. Treasury bonds has sent prices soaring and yields plummeting seems to call to combat reason.

To get a sense of to what degree much demand there is for fully-guaranteed government bonds, just look at prices over the more than few months. The benchmark 10-year Treasury note was commercial at a price of 106-22/32 for a yield of 2.974% on Nov. 26; the worth was 102-06/32, and the yield 3.73%, on Sept. 2.

Try as you might to justify these moves by citing the seemingly bottomless hunger for cash at American International Group (AIG), to the exhaustion of Lehman Brothers Holdings, to Citigroup’s (C) precarious principle, the activity in the Treasury market sparks a gust of wind of questions. Inexplicably, investors don’t seem concerned about the low-to-no yields they are acquisition for their riches.

Here are some of the Treasury market’s greatest puzzles:

Puzzle No. 1: The upward march of Treasury prices

Bill Larkin, portfolio manager for fixed profits at Cabot Money Management in Salem, Mass., thinks Treasury bonds are probably one of the utmost dangerous trades for investors right now. The stock and bond markets are pricing in the worst economy in 30 years, with no inflation expectations. "When you get into yields this low, and you get into this historic of great price girth, admitting that you plan on holding them to ripeness, you’re fine. But in real terms, adjusted for inflation, you lose," he says.

Larkin says there’s no doubt that the liquidness programs being enacted by the U.S. Treasury Dept. and the Federal Reserve will eventually stimulate vegetation and result in rising inflation, malignity concerns about how effective these policies have been thus in a great degree in responding to the fiscal crisis.

Jim Sarni, managing principal at Payden & Rygel—an investment firm in Los Angeles that manages again than $50 billion in property—calls the flight to quality into high-priced Treasury bonds a persistent disengage between market fundamentals and market valuations on one hand, and people’s desperation to avoid risk upon the body the other. He notes how quick the Treasury has been to abandon certain strategies designed to spark lending and restore confidence in favor of new programs, without completely explaining to the public—or possibly even opinion through—to that which extent the proposed measures would actually work.

"As investors, we’re all root bombarded by information that scratches the surface [in terms of trying] to solve the liquidity problems in the market," Sarni says. "Nothing is gaining traction as none of the distinct parts are known, and that’sitting manifesting itself in the community being easily frightened, which is driving them to the safest thing out there until there’s more certainty about what’s going on."

The latest announcement in continuance Nov. 25 was that the Federal Reserve plans to purchase up to $500 billion worth of mortgages bonds guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, as well while an additional $100 billion of securities from mortgage finance companies similar as the Federal Home Loan Bank. That caused engage rates on 30-year mortgages to send down three-quarters of a percentage point within one day, to around 5.5%.