Treasury Sale Sets 2nd Record Low Yield on Europe Debt

The Treasury sold notes at a record- low auction yield for a second consecutive day as Europe’s debt crisis underscored the status of U.S. government debt as the preferred refuge.

The $29 billion seven-year note sale drew a yield of 1.203 percent, compared with the previous record of 1.347 percent at the April 26 auction. Yesterday’s five-year note sale also drew an all-time low yield, as the U.S. borrows at historically low costs even as marketable Treasuries exceed $10 trillion, a more- than doubling since 2007. Benchmark 10-year yields rose today as Federal Reserve Bank of New York President William Dudley said he doesn’t currently see the need for additional stimulus.

“There is a tremendous demand for Treasuries amid strong risk aversion as problems in Europe don’t seem to be getting better and the concern grows about the potential of dipping back into recession” said Jay Mueller, who manages about $3 billion of bonds at Wells Capital Management in Milwaukee. “There are a lot of bad things happening and people are looking for a place to hide. This stuff is just so unpredictable.”

The yield on the current seven-year note rose four basis point, or 0.04 percentage point, to 1.19 percent, at 4:59 p.m. in New York, according to Bloomberg Bond Trader Prices.

The benchmark 10-year yield climbed four basis points to 1.78 percent. The 1.75 percent security due in May 2022 fell 3/8, or $3.75 per $1,000 face amount, to 99 3/4. The yield touched 1.71 percent, approaching the record low 1.6714 percent set Sept. 23.

Holiday Hours

The Securities Industry and Financial Markets Association recommended that trading of Treasuries end tomorrow at 2 p.m. New York time and fixed-income markets close May 28 in observance of the Memorial Day Holiday.

Today’s seven-year note sale yield matched the forecast of 1.203 percent in a Bloomberg News survey of eight of the Fed’s primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.80, compared with an average of 2.83 for the previous 10 sales.

Indirect bidders, an investor class that includes foreign central banks, purchased 42.7 percent of the notes, compared with an average of 40.3 percent for the past 10 sales.

Direct bidders, non-primary dealer investors that place their bids directly with the Treasury, purchased 15.7 percent of the notes, compared with an average of 13.6 percent at the past 10 auctions.

Debt Returns

Treasuries maturing in seven years have returned 2.5 percent this year after returning 14 percent in 2011, according to Bank of America Merrill Lynch indexes. The overall Treasury market has gained 1.4 percent this year after gaining 9.8 percent in 2011.

This week’s note offerings, combined with the May 17 auction of $13 billion in 10-year Treasury Inflation Protected Securities, will raise $52.9 billion of new cash, as maturing securities held by the public total $59.1 billion.

The three U.S. note auctions this week totaled $99 billion. The Treasury sold $35 billion of five-year debt yesterday at a record low yield of 0.748 percent, and the same amount of two- year securities on May 22 at 0.3 percent.

Primary dealer holdings of U.S. government debt rose to $108 billion, the highest ever, as of May 16, from a net bet against the securities of $11.9 billion in September, according to the Fed.

Historically low interest rates have allowed President Barack Obama’s administration to finance three years of budget deficits exceeding $1 trillion without igniting price increases.

While the amount of marketable Treasuries outstanding has more than doubled to $10.3 trillion from $4.4 trillion in mid- 2007, debt expense equaled 3 percent of the economy in fiscal 2011 ended Sept. 30, down from 4 percent in 1999, when the U.S. ran budget surpluses.

Dudley’s View

“The economy, I think generally, is healing, but very slowly,” Dudley said in an interview with CNBC, according to its website. “If we continue to see improvement in the economy, in terms of using up the slack in available resources, then I think it’s hard to argue that we absolutely must do something more in terms of the monetary policy front.”

The Fed will hold its policy meeting next month. The U.S. central bank bought $2.3 trillion of bonds in two rounds of quantitative easing from December 2008 to June 2011 to boost the economy.

“If that’s the case, it would be a bit of a disappointment to the market,” said Tom Tucci, managing director and head of Treasury trading in New York at CIBC World Markets Corp., referring to Dudley’s comments. “We still have another month of the European crisis and economic data to get through and those things can still change.”

Fed Buys

The central bank bought $1.8 billion of Treasuries due from February 2036 to August 2041 today, according to the Fed Bank of New York’s website. The purchases are part of the central bank’s program to replace $400 billion of shorter-term debt in its holdings with longer maturities by the end of June to support the economy.

Bill Gross, co-chief investment officer and founder of Newport Beach, California-based Pacific Investment Management Co., commented on monetary policy in a Twitter post.

“Fed’s Dudley less dovish,” he wrote. “QE III now. Depends on Euroland, inflation & jobs. 50/50.”

Treasuries have rallied since March on speculation Greece will abandon the euro as it combats a recession, leading other nations in the currency bloc to consider doing the same.

Volatility rose yesterday to 73.7 basis points from 70.8 basis points the previous day, according to Bank of America Merrill Lynch’s MOVE index, which measures Treasury price swings based on options. The gauge is below the one-year average of 87.9 basis points.

Trading Trends

Trading volume rose yesterday above the 2012 average of $242 billion. About $280 billion of Treasuries changed hands through ICAP Plc, the world’s largest interdealer broker. Volume reached $439 billion on March 14, the highest since August.

Germany has “huge difficulties” with France’s call for joint borrowing by euro governments, Chancellor Angela Merkel told reporters in Brussels early today after six hours of talks. European leaders also called on Greece to stick with budget cuts needed to stay in the euro.

The yield touched a 2012 high of 2.4 percent on March 20 and a low of 1.69 percent on May 17.

Ten-year yields will increase to 2.45 percent by year-end, according to the average forecast in a Bloomberg survey of financial companies with the most recent projections given the heaviest weightings.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

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

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