Default fears push U.S. bill rates to five-year high


* U.S. 1-month bill auction rate at highest since 2008crisis

* Weak demand signals waning confidence in timely debt deal

* Turbulence in T-bill sector seen contained for now

By Richard Leong

NEW YORK, Oct 8 (Reuters) - The normally uneventful sale ofone-month U.S. Treasury debt turned into a near-boycott onTuesday, with investors demanding the highest yields in fiveyears as fears intensified over a possible default if thefederal debt ceiling is not increased.

The U.S. Treasury Department on Tuesday sold $30 billion ofone-month bills that will pay an interest rate of 0.35 percentto investors. This was the highest one-month federal borrowingcost since October 2008 when markets worldwide were roiled bythe global credit crisis.

The high yield failed to stoke demand. The total amount bidrelative to the size of the offering came in at a ratio of 2.75to 1, lowest since March 2009.

"Until you see some progress, things will likely get worse,"said Eric Green, global head of rates, currency and commodityresearch and strategy at TD Securities in New York.

One-month T-bill auctions are typically uneventful affairs,as banks, money market funds and other cash investors buy theweekly supply with confidence because of their short maturityand the full faith and credit of the U.S. government.

That confidence is now stressed to the extreme on thelikelihood the United States might skip its debt paymentobligations after Oct. 17, when the federal government isexpected to exhaust its $16.7 trillion statutory debt limit.

The $2.66 trillion money fund industry is avoiding itsexposure to those Treasury bill issues that come due in the fourweeks following next week's deadline.

This nasty turn signaled waning confidence President BarackObama and top Republican lawmakers could agree on a pact toraise the debt limit by next week. The standoff shows few signsof being resolved soon.

In a race to raise more cash before the deadline, theTreasury will sell $35 billion in five-day debt on Wednesday.

The budget impasse in Washington has not completely drainedappetite for longer-dated government debt. The Treasury sold $30billion in three-year notes to somewhat better demandthan the earlier one-month bill sale.

"It's not about the probability for the government to pay,but the political dysfunction around it," TD's Green said.

The deterioration in the debt ceiling outlook has manifestedin other parts of the bond market. The one-month T-bill rate climbed above the fixing on the one-month Londoninterbank offered rate, known as Libor, for firsttime in at least 12 years, according to Reuters data.

"The markets now view lending money to the U.S. for onemonth as riskier than lending money to a bank for one month,"said Guy LeBas, chief fixed-income strategist with JanneyMontgomery Scott in Philadelphia.

The rate on the one-month T-bill due Oct. 31 was last quotedat 0.295 percent after it traded as high as 0.355 percent. Thiscompared with the one-month Libor at 0.1740 percent.


On Tuesday, one-month T-bill rates surpassed levels setduring the first debt ceiling showdown between President BarackObama and Republican lawmakers more than two years ago.

While interest rates on T-bill issues in October tomid-November have jumped on default worries, rates in the secondhalf of November and beyond have stayed in thesingle-basis-point range.

"This event of the one-month T-bill yields rising above 1-month Libor rates represents a signpost of increased riskrather than a large market move," LeBas said.

Other short-term loan markets have remained calmed as mostinvestors and analysts anticipated a last-minute deal betweenthe White House and Congress to raise the debt ceiling.

In the $5 trillion repurchase agreement market, which WallStreet relies on to raise cash to fund their trades, theovernight borrowing cost was about 0.10 percent, up from 0.09percent on Monday and 0.07 percent a week earlier.


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