Treasuries overcame a variety of bearish factors to close higher on Monday. Traders said a sharp decline in mortgage rates sparked a powerful round of buying.

Treasuries initially sold off and yields moved higher because of an equity rally and the expected increased U.S. government borrowing. At their highs, 2-year yields were up 22 bps to 2.52% and 10-year yields were up 16 bps to 3.85%.

But the selloff sputtered on massive duration-extension buying, traders said. As part of the bailout package, the U.S. Treasury pledged to buy mortgages. The announcement helped cut the U.S. rate for a 30-year fixed mortgage to 6.08% from 6.26% last week.

Traders explained that the lower rates will encourage homeowners to refinance and pay off their mortgage sooner. In order to match expiration with obligations, or to mirror indexes, mortgage servicers and other market participants need to buy longer-duration bonds. As much as $67 billion in 10-year equivalents will need to be purchased, according to Credit Suisse.

U.S. two-year yields were down 1.6 bps to 2.29%, with five-year yields down 2.7 bps to 2.95%, 10-year yields down 4.3 bps to 3.66% and 30-year yields down 4.8 bps to 4.25%. The Eurodollar March 09 contract was up 5.5 ticks to 97.19. The yield curve was flatter, with the 10/2-year spread down 3.2 bps to 136.52 bps.

Former Federal Reserve governor William Poole said the GSE bailout could cost $300 billion, while PIMCO managing director Bill Gross estimated it will cost $50 billion.

Tom Di Galoma, head of fixed income at Jefferies & Co, said prices will eventually fall and yields rise as the U.S. government issues additional debt.

"What we have going on here is really an overwhelming increase in supply and that is going to be an overriding factor," he said.

All data taken at 4:10 p.m. EDT.

By Adam Button and edited by Sarah Sussman
©CEP News Ltd. 2008