U.S. 10-Year Inflation Notes Draw Most Direct Demand Since 2011

The Treasury’s sale of $13 billion of inflation-indexed notes attracted the strongest demand since 2011 from a group of investors that includes pension funds and insurers, as improved economic growth prospects sparked demand for protection against rising consumer prices.

Direct bidders, non-primary-dealer investors that place orders directly with the Treasury, bought 21.5 percent of the 10-year notes sold yesterday, the most since September 2011, according to data compiled by Bloomberg. The average at the past 10 sales is 10.8 percent. The Treasury Inflation Indexed Securities sold at a yield of 0.56 percent, the highest at an auction since July 2011.

“There was decent demand for TIPS at these levels as investors are looking for inflation protection,” said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald LP in New York, one of 21 primary dealers that are required to bid at Treasury auctions. “With economic growth expected to pick up along with easy monetary policy, at some point inflation is due to rise.”

Janet Yellen, a main architect of record Federal Reserve stimulus, indicated in her Nov. 14 confirmation hearing to succeed Fed Chairman Ben S. Bernanke that she’ll press on with accommodation until she sees a robust recovery. The central bank is buying $85 billion of bonds each month to keep borrowing rates low and increase inflation to sustain the economic expansion.

Inflation-indexed securities rise or fall in value tracking changes in the consumer price index calculated by the Labor Department. Inflation adjustments will be added to the notes’ principal and interest coupon and be payable at maturity. Demand for the securities had surged in 2011 as yields on conventional Treasuries fell to almost record lows and investors sought a hedge against a possible rise in inflation from the Fed’s unprecedented monetary-stimulus measures.

Break-Even Rates

Inflation expectations have declined this year as investors begin to price in an end to the Fed’s bond-buying program. The difference in yield between 10-year notes and similar-maturity TIPS, a measure of trader expectations for rises in consumer prices over the life of the debt called the break-even rate, was 2.19 percentage points, down from a high for the year of 2.61 percent in February.

The cost of living in the U.S. declined in October for the first time in six months, showing inflation remains below the Fed’s goal. The consumer-price index dropped 0.1 percent after a 0.2 percent gain the prior month, a Labor Department report showed two days ago.

‘Some Value’

“TIPS have suffered a lot this year to the point where they may be poised to finally offer value,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York. “We haven’t seen much inflation, but with economic growth picking up, the Fed poised to taper purchases and with how beat up TIPS have been, investors are finally seeing some value.”

TIPS have lost 8.4 percent this year after returning 7.3 percent in 2012, according to Bank of America Merrill Lynch’s U.S. Inflation-Linked Treasury Index, and are on track for their worst year since the securities were first issued in 1998. The broader Treasury market has fallen 2.6 percent this year, compared with a 2.2 percent gain in 2012, the indexes show.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.59 at yesterday’s sale, the strongest level since March and compared with 2.61 for the past 10 auctions.

Indirect bidders, a class of investors that includes foreign central banks, bought 46.7 percent of the 10-year TIPS auctioned. They purchased 53.8 percent at the September sale. The average for the past 10 offerings is 50 percent.

Primary dealers won 31.8 percent of the offering, compared with 44.6 at the previous sale.

Investors bid $2.87 for each dollar of the $1.868 trillion in U.S. government notes and bonds sold at auction this year, according to Treasury data compiled by Bloomberg. That’s down from the record $3.15 for the $2.153 trillion sold at last year’s offerings.

To contact the reporter on this story: 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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