Treasuries Drop as Refuge Appeal Diminishes, Record Five-Year Notes Sold

Treasuries fell for the first time in three days as the refuge appeal of government securities faded and the U.S. sold $42 billion in five-year notes.

Notes jumped the most this year yesterday after Greece had its debt rating cut to junk by Standard & Poor’s, raising concern that the fiscal crisis is spreading through Europe. The Federal Reserve reiterated that it will keep interest rates low for an “extended” period of time.

“Some of the flight-to-quality bid that the market received yesterday is flowing out of Treasuries and back into risk markets,” said William Cunningham, head of fixed-income and credit research at State Street Corp. in Boston. “The bottom line is the Fed keeping rates low is good news for equities and risk taking.”

The yield on the benchmark 10-year note rose eight basis points to 3.76 percent at 4:02 p.m. in New York, according to BGCantor Market Data. The 3.625 percent security due February 2020 fell 21/32, or $6.56 per $1,000 face amount, to 98 28/32.

Yields on 10-year debt slid 12 basis points yesterday, the biggest drop since Dec. 17, and touched 3.67 percent, the lowest since March 23.

The five-year notes sold today drew a yield of 2.54 percent, compared with an average forecast of 2.532 percent from six of the Fed’s 18 primary dealers surveyed by Bloomberg News.

FOMC Statement

“Economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the Federal Open Market Committee said in a statement today in Washington.

Chairman Ben S. Bernanke is contending with an economy that’s been growing for almost a year without an increase in inflation or a decline in unemployment below 9.7 percent. While consumer spending is recovering along with business investment, credit to households remains tight. A surge in corporate profits last quarter was led by demand from overseas and lower labor costs, according to results from Standard & Poor’s 500 companies that have reported earnings this month.

“No change is something that buys us more time and takes one thing to worry about off the table,” said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, which oversees $22 billion. “They needed to make this statement as innocuous as possible.”

U.S. central bankers have kept the benchmark lending rate in a range of zero to 0.25 percent since December 2008. Kansas City Fed President Thomas Hoenig dissented for the third straight meeting.

Increased Bidding

Investors bid for 2.75 times the amount of five-year notes sold, compared with 2.55 times at the last auction on March 24. The average bid-to-cover ratio of the past 10 sales was 2.55. The sale was the third in a series of five auctions this week of a record $129 billion in inflation-protected debt and notes.

Indirect bidders, a class of investors that includes foreign central banks, bought 48.9 percent of the notes, compared with 39.7 percent at the March sale, the lowest level since July 2009. Indirect bids averaged 49.3 percent in the prior 10 offerings.

“We’ve had a pretty good sell off over the past day which has brought buyers in to the auction,” said Ward McCarthy, chief financial economist in New York at primary dealer Jefferies & Co. Inc. “The five year sector seems like a popular place to be right now.”

The U.S. sold $44 billion of two-year notes yesterday at a yield of 1.024 percent, compared with the average forecast of 1.022 percent in a Bloomberg survey of eight primary dealers, companies required to bid at the Treasury’s debt sales.

‘Minority View’

Some traders and investors had speculated that the Fed would remove language asserting it will hold rates low for an “extended period” or that it would discuss selling some of the $1.25 trillion in mortgage securities it bought in the 16 months through last March, though that is “a minority view,” according to Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut.

Policy makers were also forecast to be reluctant to push borrowing rates higher soon given the fiscal crisis in Greece. S&P forecast investors would be paid no more than half their initial outlay in the event of any restructuring of Greek debt when cutting the ratings. S&P lowered the long-term sovereign ratings on Greece to BB+ from BBB+, and also reduced Portugal’s long-term local and foreign-currency sovereign-issuer credit ratings to A- from A+.

“The last thing the Fed wanted to do was to introduce any more volatility into the markets against the backdrop of the sovereign debt issues coming out of Europe,” Cunningham of State Street said.

Fed Funds Futures

Spain had its credit rating cut one step by S&P to AA, putting it on a par with Slovenia. S&P said in a statement that the outlook on Spain is negative, reflecting the chance of a possible further downgrade if the “budgetary position underperforms to a greater extent than we currently anticipate.”

Fed fund futures traded on the CME Group Inc. exchange showed a 59 percent chance the Fed will raise its target rate by at least a quarter point by year-end, down from 76 percent odds a month ago.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net.

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