Treasuries gained after the government’s $36 billion auction of two-year notes drew the highest level of demand since August 2007 as investors speculated the Federal Reserve will buy more government bonds.
Bonds rose earlier as Anglo Irish Bank Corp.’s senior debt was cut to the lowest investment grade rating by Moody’s Investors Service, encouraging demand for safety. The two-year notes sold today drew a yield of 0.441 percent, the lowest since the government began selling the securities on a quarterly basis in September 1974.
“There are a lot of positives for the market,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “There’s a lot of cash on the sidelines, and the economic outlook is uncertain. It’s the perfect environment to buy fixed-income.”
The 10-year note yield dropped 10 basis points, or 0.10 percentage point, to 2.51 percent at 1:31 p.m. in New York, according to BGCantor Market Data. The price of the 2.625 percent security maturing in August 2020 increased 27/32, or $8.44 per $1,000 face amount, to 100 31/32.
The current two-year note yield dropped 2 basis points to 0.42 percent, compared with the all-time low of 0.41 percent touched Sept. 22. The 30-year bond yield slid 10 basis points to 3.70 percent. The rate on the one-month bill dropped to 0.0649 percent, the lowest since June 29.
At today’s two-year note auction, the bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.78, the highest in more than three years. The yield was lower than the 0.446 percent forecast in a Bloomberg News survey of 6 of the Fed’s 18 primary dealers, which are obligated to participate in U.S. auctions.
Indirect bidders, an investor class that includes foreign central banks, purchased 39 percent of the notes, compared with 29.2 percent at the last auction on Aug. 24. Two-year notes drew a then record-low yield of 0.498 percent last month.
Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 10.8 percent, compared with 12.1 percent in August and an average of 14.1 percent at the past 10 auctions.
The size of the two-year note offering was the smallest since November 2008. The Treasury will auction $35 billion in five-year notes tomorrow and $29 billion in seven-year debt Sept. 29.
“Demand for Treasuries will remain fairly robust despite the amount of supply hitting the market this week,” Kevin Giddis, head of fixed-income sales, trading and research in Memphis, Tennessee, at the brokerage firm Morgan Keegan Inc., said in a research note. The economy remains weak, and the Fed appears poised to intensify asset purchases, he wrote.
The Fed said in its statement after its Sept. 21 meeting that it’s prepared “to provide additional accommodation if needed to support economic recovery and to return inflation, over time, to levels consistent with its mandate.”
Consumer prices excluding food and energy increased in August for a fifth month at an annual rate of 0.9 percent, matching the slowest year-over-year pace of gains since 1966, the Labor Department said Sept. 17.
The difference between yields on 10-year notes and Treasury Inflation Protected Securities, or TIPS, a gauge of trader expectations for consumer prices over the life of the maturity known as the break-even rate, fell to 1.79 percentage points, compared with the five-year average of 2.10 percentage points.
Deutsche Bank View
About $315 billion to $670 billion of quantitative easing has been priced in by the market, a team of Deutsche Bank AG analysts including Dominic Konstam and Mustafa Chowdhury in New York wrote in a note to clients issued Sept. 24.
The Fed completed a program of quantitative easing in March, purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The central bank was the biggest buyer of Treasuries when it bought $300 billion of U.S. debt in 2009.
The central bank retained last week its stance from its Aug. 10 meeting of keeping its portfolio of securities stable at about $2 trillion to keep money from draining out of the financial system.
A range of 2.50 percent to 2.70 percent for the 10-year note yield will probably hold until traders “get in touch with their feelings” on the probability of full-scale quantitative easing, Jim Vogel, head of agency-debt research at FTN Financial in Memphis, wrote in a note to clients.
This year’s rally in Treasuries has pushed yields so low that a Fed measure of risk shows U.S. government securities are too expensive.
The financial model, which includes expectations for interest rates, growth and inflation, shows Treasuries are the most overvalued since the financial crisis in December 2008, just before 10-year note yields almost doubled in the following six months. Investors who held 10-year securities through that period lost 13 percent, according to Bank of America Merrill Lynch index data.
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