U.S. asset prices whipsaw as Lehman talks falter

NEW YORK (Reuters) - U.S. stock futures and the dollar sank late on Sunday as the first official trades of a new business week took place while talks to sell Lehman Brothers faltered, shaking confidence and pushing dollar-exposed investors towards safe haven U.S. Treasuries.
U.S. Treasury yields fell sharply in early Asian trade on Monday and Eurodollars surged as concerns about the stability of the U.S. financial system sparked talk of emergency liquidity measures by the Federal Reserve or even a cut in interest rates.

Two-year Treasury notes jumped 20/32 in price, driving yields down to a five-month low of 1.90 percent, from 2.22 percent late in New York on Friday while yields on 10-year notes dropped to 3.56 percent, from 3.72 percent.

U.S. stock index futures pared earlier falls in New York late Sunday, but still pointed to a steep drop when trading begins on Monday, with S&P 500 futures down 28 points and the Dow Jones industrial average futures off 211 points and Nasdaq 100 futures 31 points softer by 2330 GMT (12:30 p.m. British time).

The U.S. dollar fell around a cent versus the euro in opening trade in Sydney and was quoted around $1.4300 at 2340 GMT, compared with $1.4225 in late U.S. trade on Friday. Against the yen, the greenback dropped to 106.70/75 yen versus 107.86 yen and the Australian dollar extended gains above U.S. 82 cents .

Three-month Eurodollars were sharply higher across the curve <0#ED:>, with the December contract jumping 0.195 to 97.260 and March next year up 0.280 at 97.465.

"It appears that Lehman will file for bankruptcy and the risk of an immediate tsunami is related to the unwind of derivative and swap-related positions worldwide in the dealer, hedge fund, and buyside universe," Bill Gross, the chief investment officer of Pacific Investment Management Co (Pimco), told Reuters. Pimco oversees more than $812 billion in assets.

Uncertainty about the health of the U.S. financial sector was running high with the fate of the 158-year old investment bank Lehman Brothers still unclear. In addition, a takeover of Merrill Lynch & Co and huge asset sales by American International Group were being talked about in markets.

That uncertainty fuelled talk in Asian markets that the Fed, which holds a policy meeting on Tuesday, could announce fresh measures to boost liquidity in the financial system or even cut interest rates.

"You have to assume they will be standing by with extra liquidity, though it's hard to know what extra they could do," said Tony Morriss, senior currency strategist at ANZ. "The Fed may say something reassuring after its meeting and I suppose a rate cut is not out of the question, though unlikely."

The Fed thus far has been expected to keep benchmark lending rates on hold at two percent at its Tuesday meeting, after slashing overnight rates 3.25 percentage points between mid-September 2007 and the end of April in response to the deepening credit crunch that has wracked global markets.

On Sunday, a rare emergency trading session opened in New York to allow Wall Street dealers in the $455 trillion derivatives market to reduce their exposure to a potential bankruptcy filing by Lehman.

U.S. regulators and bankers were making last-ditch efforts on Sunday to prevent toxic assets from ailing Lehman Brothers spilling into global markets and rupturing investor faith in the international financial system.

While the fate of the U.S. financial system was the focus of most early trading, initial reports that the passing of Hurricane Ike through country's energy production centre had not severely damaged infrastructure in Texas saw benchmark oil prices fall more than to $2 to a six-month low below $99 a barrel.

"The oil market is selling off because the early indications show Ike didn't do as much damage as feared," said Chris Jarvis, senior analyst at Caprock Risk Management. "That said, this sell-off could prove to be a bit premature, since it could be a while before things get back to normal."

Oil fell $2.38 to $98.80 a barrel by 2150 GMT after falling as low as $98.46 -- the lowest since February 26 -- adding to a steady downtrend prices since mid-July's peak of over $147 a barrel as evidence mounts that high energy costs and a weakening economy are cutting into fuel consumption.

SPECIAL TRADING SESSIONS

But it was the special trading session opened for financial derivatives dealers that sources said was initiated by the U.S. Federal Reserve, that set the wider tone for asset markets.

Trading involved credit, equity, rates, foreign exchange and commodity derivatives with the aim of reducing risk associated with a potential bankruptcy filing by Lehman Brothers Holdings Inc.

"Trades are contingent on a bankruptcy filing at or before 11:59 p.m. New York time Sunday (0359 GMT)," said the statement. "If there is no filing, the trades cease to exist."

Britain's Barclays Plc , which had appeared to be the frontrunner to take over Lehman -- excluding its bad mortgage-related assets -- pulled out of the bidding early in the afternoon, according to a person familiar with the matter.

That raised the risk of a Lehman bankruptcy. Lehman hired law firm Weil Gotshal & Manges to prepare a potential bankruptcy filing, the Wall Street Journal reported on Saturday in its online edition, citing a person familiar with the matter.

A turbulent open on U.S. financial markets was expected despite the special session, said Mark Grant, managing director of structured finance at Southwest Securities, based in Dallas.

"The market is going to be spooked. People will be fearful and no one outside a very small group of people knows what Lehman going into liquidation will mean," he told Reuters.
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