A spate of disappointing euro zone news Tuesday, from worse-than-expected growth data to an underwhelming Germany-France summit, nudged Treasurys prices closer to a new round of all-time highs.

Benchmark 10-year notes jumped up, forcing yields, which move inversely to prices, to their lowest level in four days. Yields across the curve followed in almost lock-step. The unprecedented levels are throwing the market into polarization: one camp of investors thinks the dip in yields is too sharp and running out of steam, and another says they'll keep falling because there's simply nothing in the near-future to prop them up.

Meanwhile, one closely-watched weekly Treasurys sentiment survey shows the highest amount of neutral market positions on record.

Speculation had grown in recent days that euro-zone nations need to adopt bolder measures to contain the debt crisis that's moving closer to the shores of the region's biggest economies. One option that gained popularity was a bond guaranteed by the entire euro zone, something that would help cut borrowing costs for fiscally strapped countries.

But German Chancellor Angela Merkel and French President Nicolas Sarkozy, who met Tuesday in Paris, poured cold water on that idea, sending Treasurys yields soaring to session highs. German officials say the euro zone bond idea would foster irresponsible fiscal policies among countries whose fiscal issues ignited the debt crisis in the first place.

"No mention of euro bonds means that the region's debt problem is being addressed in a passive fashion at a time where aggressive action may be required," said Kevin Giddis, president of fixed income capital markets at Morgan Keegan Inc. in Memphis, Tennessee. "This has caused yet another flight to quality situation."

Alan De Rose, head Treasury trader at Oppenheimer and Co. in New York, said the Treasurys rally reflected the thought that "more indecision amongst European political leaders was going to lead to more market turmoil and slower growth."

Indeed, earlier data showed Germany's economy barely grew in the second quarter, with gross domestic product rising only 0.1% from the previous quarter. Spanish growth was also worse-than-expected, along with overall euro zone growth. That data overrode the better-than-expected US industrial production data.

In late-afternoon trade, the benchmark 10-year note was 16/32 higher to yield 2.228%. The 30-year bond was 1 11/32 higher to yield 3.674%. The 10-year yield hit a record low of 2.033% last week and has tumbled from this year's peak of 3.77% set in February.

The bull run is pushing some investors to revise their yield forecasts lower, with Goldman Sachs cutting its 10-year forecast to 2.75% by the end of December from a previous call of 3.5%. Others think the yield fall has been too sharp, that the market has priced in plenty of bad news and that any better-than forecast data will spark a round of profit-taking.

JPMorgan's closely watched weekly client Treasurys survey, meanwhile, shows 85% of participants as having "neutral" sentiment on the future direction of the market. That's the highest level since the survey started in 1991.

"Investors are reluctant to jump into lower yields," said Srini Ramaswamy, head of JPMorgan's liquid-markets strategy, the team that conducts the survey.

US Swap Spreads Mixed

U.S. two-year swap spread, which measures the differential between the two-year swap rate and two-year Treasury yield and is a main gauge of credit risk, was unchanged at 25.5 basis points. The 10-year swap spread was 1.25 basis points tighter to 13 basis points.

COUPON ISSUE PRICE CHANGE YIELD CHANGE
3/8% 2-year 100 11/32 flat 0.187% flat
5/8% 3-Year 100 16/32 up 2/32 0.329% -1.9BP
1 1/2% 5-year 102 24/32 up 7/32 0.932% -4.7BP
2 3/8% 7-Year 104 25/32 up 12/32 1.520% -5.9BP
3 1/8% 10-year 99 2/32 up 16/32 2.228% -5.9BP
4 3/8% 30-year 101 12/32 up 1 11/32 3.674% -7.4BP

2-10-Yr Yield Spread: +204.1 BPS Vs +209.2 BPS

Source: Tradeweb