U.S.’s $21 Billion Notes Sale Undermines Budding Rally

Foreign investors showed the least demand for Treasury 10-year notes at a U.S. auction of the debt in 13 months, suggesting that the biggest bond-market rally in three years risks running out of steam.

Benchmark 10-year yields dropped from a four-week high as stocks fell amid forecasts for slower global growth and the U.S. posted the smallest budget shortfall for the first eight months of a fiscal year since 2008. Bill Gross, manager of the world’s largest bond fund, called German bund yields at almost the least versus their U.S. peers this millennium “a magnet” to lower Treasury yields. The U.S. will conclude this week’s auctions with a $13 billion sale of 30-year bonds tomorrow.

“The rally in Treasuries is hanging in with the equity-market weakness, which is giving bonds some support,” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co. “We are consolidating around these levels, but the general atmosphere is leaning bearish.”

The current 10-year note yield was little changed at 2.64 percent at 5 p.m. New York time, according to Bloomberg Bond Trader data. The price of the 2.5 percent notes maturing in May 2024 was 98 25/32.

Yields on the benchmark securities earlier climbed to 2.66 percent, the highest since May 12, and dropped to as low as 2.61 percent.

Treasuries returned 2.6 percent this year through yesterday, according to the Bloomberg U.S. Treasury Bond Index (BUSY), the best start to a year since 2011.

Notes Auction

The notes in today’s reopening auction drew a yield of 2.648 percent, compared with a forecast of 2.633 percent in a Bloomberg News survey of seven of the Federal Reserve’s 22 primary dealers.

Indirect bidders, an investor class that includes foreign central banks, purchased 36.1 percent of the notes, the least since May 2013 and compared with an average of 45.2 percent for the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 19.4 percent, compared with an average of 18.9 percent at the past 10 sales.

Primary dealers at today’s auction bought 44.5 percent of the securities, the most since July 2013 and compared with 29.1 percent last month.

‘Too Rich’

“It wasn’t as strong as we had been expecting,” said Aaron Kohli, an interest-rate strategist in New York BNP Paribas SA, which as a primary dealers is obliged to bid at U.S. debt auctions. “It suggests the 30-year may have a slightly tougher time, although its in its own space. It suggests levels in Treasuries were getting a little too rich even for the permanent bulls.”

The auction was the second of three offerings this week. The U.S. sold $28 billion of three-year debt yesterday at a yield of 0.93 percent. The sales will raise $30 billion of new cash, as maturing securities held by the public total $32 billion, according to the U.S. Treasury.

Ten-year notes have returned 4.9 percent this year, compared with a 2.5 percent gain in the broader U.S. Treasuries market, according to Bank of America Merrill Lynch indexes. The benchmark notes lost 7.8 percent in 2013, versus a 3.4 percent decline by Treasuries overall.

Stocks fell as the World Bank cited weaker outlooks for the U.S., China and Russia as it lowered the forecast for global growth to 2.8 percent from 3.2 percent in January.

The U.S. posted a $130 billion budget deficit in May, about $9 billion less than the shortfall in May 2013, the Treasury Department said in Washington. The median estimate in a Bloomberg survey of 20 economists called for a $130.5 billion gap.

‘Bond Bears’

Treasuries dropped yesterday as the yield at the three-year notes auction was the highest since May 2011, and an industry gauge of small-business optimism climbed to the most since 2007. Current three-year note yields rose four basis points today to 0.93 percent.

U.S. economic reports tomorrow and the following day will show retail sales rose in May, initial claims for jobless insurance were little changed in the latest weekly report and consumer confidence improved in June, based on Bloomberg surveys.

The Fed is reducing its monthly asset purchases, while keeping the target for overnight lending between banks in a range of zero to 0.25 percent. Policy makers signaled at their April 29-30 meeting that interest rates will stay low for a “considerable time.” They next meet on June 17-18.

Fed Waiting

“The market apparently wants to take a wait-and-see approach, with next week’s Fed’s meeting hanging over the market,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York.

The chance of a rate increase to 0.5 percent or more by March 2015 is 17 percent, according to Bloomberg-compiled data based on federal fund futures. The odds of a boost by December of next year are 72 percent.

The gap between yields on 10-year Treasuries and similar maturity German bunds was at 1.24 percentage points, the widest since July 1999 as new ECB stimulus measures pushed European bond yields lower last week.

“With German 10-year yields at 1.35 and relatively inert, they act as a magnet to bring U.S. Treasuries lower in yield,” Gross, founder of Pacific Investment Management Co., wrote in a note on Twitter.

Government-bond investors in the exchange-traded fund market have preferred longer-dated government debt this month. The iShares 20+ Year Treasury Bond saw inflows of $503 million, the second most of any fixed-income ETF. At the same time, the iShares three- to seven-year Treasury bond ETF saw outflows of $85 million.

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 editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Kenneth Pringle

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