By Richard Leong
NEW YORK (Reuters) - More grim economic news sparked investors to favor safe-haven Treasury debt on Monday and dump some stocks ahead of a Federal Reserve meeting that is expected to send key short-term rates to record lows.
The urgency for the Fed to take more bold steps intensified in the wake of fresh data showing plunging prices and a manufacturing contraction led by the woeful auto sector, factors that were weighing on stocks.
The latest evidence of deflation, which can tip a weak economy into a downward spiral, was the record decline in the "prices paid" index in the New York Fed's "Empire State" manufacturing report.
The worsening economy had investors eager to pile into cash and other safe-haven assets.
"Those who are buying are pretty much telling the market that they don't think we are near a bottom and the current recession will be with us for a while," said Kevin Giddis, head of fixed-income sales, trading and research at Morgan Keegan in Memphis, Tennessee.
In fact, the one-month Treasury bill rate briefly traded below zero percent, suggesting investors were willing to suffer small losses as long as they believed their holdings were shielded from the harsh financial climate.
"It doesn't seem to matter how much the Treasury brings to market because investors are so worried about the stability of the financial system that they are willing to accept zero return on their investment," Giddis said.
Worries of a deep protracted U.S. recession, which should keep long-term borrowing costs low for a sustained period, bolstered demand for long-maturity Treasuries.
The 10-year U.S. Treasury note gained 8/32 in price to 110-16/32. Its yield, which moves inversely to price, was 2.54 percent, down from 2.57 percent late on Friday.
The major U.S. stock indexes were down about 1 percent to 2 percent in midday trading.
FED UNDER PRESSURE
Given the grim economic outlook, U.S. central bankers are under tremendous pressure to ease monetary policy further to stem deflation and bring the United States out of recession, analysts said.
The Fed is widely expected to pare the benchmark federal funds target rate by at least half a percentage point to 0.50 percent, the lowest on record dating back to July 1954.
With short-term market rates already reflecting a Fed move to cut rates to rock-bottom levels, traders increased bullish bets on long-dated Treasuries to capture higher yields through so called curve-flattening trades.
The spread between two-year and 10-year notes narrowed to 177 basis points from 180 basis points late Friday.
Among other maturities, five-year Treasuries were up 1/32 for a yield of 1.50 percent, down from 1.51 percent late on Friday, while the 30-year bond was up 21/32 to yield 3.02 percent, down from 3.05 percent late Friday.
On the supply front, the U.S. Treasury said it will sell $25 billion in 1-month bills and $22 billion in one-year bills on Tuesday.
It will sell a combined $54 billion in three-month and six-month bills later on Monday.
(Reporting by Richard Leong; Editing by Jan Paschal)