Tags: Treasury | Sale | Yields | Higher

Treasury Sale Solid But Yields Move Higher

Tuesday, 09 Aug 2011 02:04 PM

Investors flocked to Treasurys just two trading days after a downgrade from Standard & Poor's, producing the lowest-ever yield for a three-year sale.

The $32 billion auction drew a high yield of 0.50 percent, with 3.29 times as much bid as auctioned, a measure known as the bid-to-cover ratio.

The auction marks the first sale in a three-part refunding that includes a sale of 10-year notes Wednesday and 30-year bonds Thursday.

The high demand came even on a negative day for Treasurys, which fell in price as investors ventured back into riskier assets, looking for value after Monday's global selloff in stocks, corporate bonds and industrial commodities.

Treasury prices fell further despite the solid auction.

Major stock indexes were all higher in afternoon trading.

In contrast, the benchmark 10-year Treasury note was last down 18/32, its yield rising to 2.37 percent, erasing about 1/3 of the previous day's gain.

"The bond market is reacting to the bounce-back in stocks," said Justin Hoogendoorn, fixed income strategist at BMO Capital Markets in Chicago.

Bond dealers got ready for the first U.S. Treasury note auction since Standard & Poor's downgraded U.S. Treasury debt.

Apart from being the first Treasury note sale since S&P's downgrade, the three-year note auction preceded Federal Reserve statement.

The Fed's policy-making Federal Open Market Committee held a regularly scheduled meeting and is expected to issue a statement at about 2:15 p.m., just an hour and a quarter after the 1 p.m. bidding deadline for the three-year Treasury notes.

How the U.S. Treasury market will react to a Fed statement is complicated by the fact that bonds could have both direct and indirect reactions to the Fed's message and whether bonds move up or down will depend on which of those dominate.

A dovish Fed statement could support riskier assets like stocks, spread product, and industrial commodities. That could leave bond prices lower and yields higher as investors feel less compelled to buy safe-haven assets.

But a dovish Fed statement would also be supportive for bonds. Language asserting that the U.S. central bank will keep short-term rates low for an extraordinarily long time, a more emphatic pledge than the Fed's current "extended period" language, could encourage bond investors to buy longer-dated Treasurys to capture better returns.

A dovish Fed statement that left the door open to a third phase of quantitative easing involving more Fed purchases of U.S. Treasurys could cause those Treasurys to rally, especially in the so-called belly of the curve.

The need for duration, asset allocations, a Fed desperately holding to a zero interest-rate policy, "and a small opening of the door on QE3 ... will ultimately benefit the belly," said David Ader, head government bond strategist at CRT Capital.

But while the FOMC policy announcement is "clearly the big event this week, investors may be disappointed as they look for more from (Fed Chairman Ben) Bernanke than he can deliver at this meeting," said Cary Leahey, managing director and senior economist at Decision Economics in New York.

"While weaker economic activity and market dislocations make Fed easing more likely, a sizable minority of FOMC members think the Fed has done enough and that a further expansion of the Fed's balance sheet is not the medicine the economy needs," he said.

"GDP growth is anemic, but jobs are being created in 2011, unlike this time in 2010 when payrolls were shrinking," he noted. "As long as the economy churns out job growth, the hawks are not ready to return to the nest and become doves."

Still, if the Fed soft pedals the economic assessment, if they discuss lower commodity prices, if they talk again about using "tools to promote recovery," or if they mention "unsettled" market conditions, that could comfort stock investors, Leahey said.

Too big of a response to a dovish Fed statement "could bring on a Fed clarification later in the week, not unlike what happened to markets on the first and second day of Bernanke's most recent Humphrey-Hawkins testimony," Leahey said.

© 2015 Thomson/Reuters. All rights reserved.

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