Treasuries Remain Higher as Two-Year Securities Sold at Record Low Yield

Treasuries remained higher as the government sold $36 billion of two-year securities in the first of three note auctions this week totaling $100 billion.

The auction drew a record-low yield of 0.441 percent, compared with the 0.446 percent forecast in a Bloomberg News survey of 6 of the Federal Reserve’s 18 primary dealers. The sale’s bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.78, compared with an average of 3.14 at the past 10 auctions. Treasuries rose earlier on speculation the Fed will increase purchases of U.S. debt to boost the economy and on concern Ireland’s finances are deteriorating.

“Today we are in a slight panic mode,” said Tom Roth, senior Treasury trader in New York at Bank of Tokyo-Mitsubishi UFJ Ltd., before the sale. “Everything stacks up for the auction to go well. People are more inclined to think QE will happen.”

Current two-year note yields slid 2 basis points, or 0.02 percentage point, to 0.426 percent at 1:05 p.m. in New York, according to BGCantor Market Data. The 10-year note yield dropped 9 basis points to 2.52 percent.

At today’s sale, 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 and an average of 38.1 percent at the past 10 sales. Two-year notes drew a then record-low yield of 0.498 percent at last month’s auction.

Direct Bidders

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 offering today 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.

Bonds rose earlier as Anglo Irish Bank Corp.’s senior debt was cut to the lowest investment grade rating by Moody’s Investors Service.

The company’s government-guaranteed senior bonds fell for a sixth day as investors wagered they’ll be forced to share the cost of bailing out the nationalized lender with taxpayers.

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.

Break-Even Rate

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.

“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.

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 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.

Fed Debt Buying

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. The Fed will buy inflation-indexed debt tomorrow maturing from January 2011 to February 2040 as part of its program to reinvest principal payments from its mortgage holdings.

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.

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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