Are there only two hoses going to the backhoe? I believe the valve in the picture, is a diverter valve used to send the hydraulic flow to the backhoe. It is like a safety check valve so the tractor controls don't work while you are operating the backhoe. I don't think this is where your problem lies, rather I believe it to be in the main backhoe control valve unit. Your swing control valve is where I would start first because it should not be operating when the fender valve is pulled up. Another thing, your steering should not work better with the valve in the backhoe position, rather all flow should be directed to the workings of the backhoe.