U.S. 10-Year Note Yields Hits 5-Week High as Auction Bids Shrink

Treasury 10-year yields reached a five-week high as a $24 billion sale of the notes attracted the least demand in three years, leaving the Wall Street banks required to bid at government auctions with their largest share of the offering since October.

Last month, the previous U.S. 10-year sale drew record high demand from a group of investors that include pension funds and insurance companies, who were awarded 45.4 percent of the notes. At today’s sale, the Federal Reserve’s 21 primary dealers bought 54.2 percent of the offering, their largest share since October. Treasuries rose earlier on haven demand as a German industrial production drop, lower U.K. growth forecasts and ratings cuts for Spain and Italy raised concern Europe’s sovereign-debt crisis is worsening.

“The market is starting to look for a more fair market price and that means higher yields,” said William O’Donnell, head U.S. government-bond strategist at Royal Bank of Scotland Group Plc’s RBS Securities Inc. in Stamford, Connecticut, a primary dealer. “Weak bid-to-cover and indirect buying is also reflective of quiet conditions we’ve seen both in Europe and domestically.”

The yield on the current 10-year note rose two basis points, or 0.02 percentage point, to 1.65 percent, at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The 1.75 percent note due in May 2022 lost 6/32, or $1.88 per $1,000 face amount, to 100 29/32. The yield touched the highest since June 29.

Bid Data

The 10-year auction produced a yield of 1.680 percent, compared with a forecast of 1.656 percent in a Bloomberg News survey of 10 of the Federal Reserve’s primary dealers.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.49 matching the figure from August 2009, and compared with 3.61 in July and an average of 3.1 for the previous 10 sales.

Indirect bidders, an investor class that includes foreign central banks, purchased 40.6 percent of the notes, compared with an average of 41.4 percent for the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 5.2 percent of the notes, the lowest since February 2011 and compared with a record 45.4 percent last month and an average of 17.1 percent at the last 10 auctions.

Skittish Dealers

“Dealers were skittish about setting up for the auction,” said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, a primary dealer. “You don’t know if there’s going to be a big direct bid,” which can push yields below the market level heading into the offering.

The record direct bid at the July 11 sale left dealers with a record low 14 percent of the offering. “It makes you wind up being left short and not being able to get the bonds back,” Jersey said.

Before sales of government debt, dealers typically try to push yields higher, often taking short positions, or bets that yields will rise, in order to buy the securities at levels that will be more attractive to investors.

The sale was the second of three this week totaling $72 billion, with the U.S. auctioning $16 billion of 30-year bonds tomorrow. A $32 billion three-year note sale yesterday drew a yield of 0.37 percent.

Ten-year U.S. debt has returned 3.9 percent this year, nearly doubling the 2 percent gain in the broader Treasury market. The notes returned 17 percent in 2011, almost double the 9.8 percent gain by Treasuries overall, according to Bank of America Merrill Lynch indexes.

Fed Moves

The Fed bought $1.9 billion of Treasuries due from February 2036 to May 2042 today, with according to the Fed Bank of New York website.

The central bank received $5.901 billion in offers to sell bonds, or $3.03 for every dollar of debt it sold. The Fed’s Aug. 6 purchase of $4.646 billion of debt maturing from August 2020 to May 2022 attracted $2.51 in bids for each dollar of debt.

The purchases are part of Chairman Ben S. Bernanke’s plan to contain borrowing costs by swapping short-term Treasuries in the central bank’s holdings for longer maturities. The Fed is swapping shorter-term Treasuries in its holdings with longer- dated debt to put downward pressure on long-term borrowing costs.

“The more people wanting to sell bonds indicate that people think the market is a little toppy,” or at a high in price, said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York.

Debt Rating

S&P lowered its outlook on Greece’s debt to negative from stable, which means it is more inclined to reduce its ranking for the nation. Spain was cut two steps to A (low) from A (high) and Italy was downgraded one level to A, Toronto-based DBRS said in a statement. Ireland’s grade was confirmed at A (low), four steps from junk.

German exports, adjusted for work days and seasonal changes, dropped 1.5 percent in June from May, when they jumped 4.2 percent, the Federal Statistics Office said in Wiesbaden. Industrial production fell 0.9 percent from May, when it gained 1.7 percent, the Economy Ministry said in Berlin.

Treasury trading volume reported by ICAP Plc, the largest inter-dealer broker of U.S. government debt, averaged $197 billion in the two previous trading days this week, compared with an average of $253.2 billion last week. Trading has averaged $240.7 billion this year.

“Volumes are down,” said Guy Haselmann, an interest-rate strategist at primary dealer Bank of Nova Scotia in New York. “People are prepared to act, but only when they know what they’re really responding to. They just don’t want to get caught up in the illiquidity and noise of the summer marketplace.”

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

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

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