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Treasuries Rise as Note Auction Draws Highest Demand Since 2007

Sept. 27 (Bloomberg) -- Treasuries gained after the government’s $36 billion auction of two-year notes drew the highest level of demand since August 2007 as investors speculated the Federal Reserve will buy more government bonds.

Bonds rose earlier as Anglo Irish Bank Corp.’s senior debt was cut to the lowest investment grade rating by Moody’s Investors Service, encouraging demand for safety. The two-year notes sold today drew a yield of 0.441 percent, the lowest since the government began selling the securities on a quarterly basis in September 1974. The U.S. will sell $35 billion in five-year notes tomorrow.

“The market is getting its arms around the fact that we are moving closer to QE II,” said Thomas Tucci, head of U.S. government bond trading in New York at Royal Bank of Canada, one of 18 primary dealers that trade directly with the Fed. “There is banking system sensitivity to how much exposure the European banks have to each country. That will continue to keep a flight-to-quality bid.”

The 10-year note yield dropped 8 basis points, or 0.08 percentage point, to 2.53 percent at 4:36 p.m. in New York, according to BGCantor Market Data. The price of the 2.625 percent security maturing in August 2020 increased 23/32, or $7.19 per $1,000 face amount, to 100 27/32.

The current two-year note yield dropped 2 basis points to 0.42 percent, compared with the all-time low of 0.41 percent touched Sept. 22. The 30-year bond yield slid 10 basis points to 3.70 percent. The rate on the one-month bill dropped to 0.0649 percent, the lowest since June 29.

Auction Demand

At today’s two-year note auction, the bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.78, the highest in more than three years. The average forecast of 6 of the Fed’s primary dealers was for a yield of 0.446 percent.

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. Two-year notes drew a then record-low yield of 0.498 percent last month.

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 note offering was the smallest since November 2008. The Treasury will auction $29 billion in seven-year debt on Sept. 29 in the last of three note sales totaling $100 billion.

Market ‘Positives’

“There are a lot of positives for the market,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “There’s a lot of cash on the sidelines, and the economic outlook is uncertain. It’s the perfect environment to buy fixed-income.”

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.”

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 of quantitative easing 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.

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.

Anglo Irish Bank 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 Sunday Times reported yesterday that Ireland’s government may seek to buy back Anglo Irish debt at a discount or swap it for equity in the new asset recovery bank it’s creating. The final cost of the bailout, which has already cost Ireland 22.9 billion euros ($31 billion), is expected to be announced this week as the government seeks to quell concern it will require funds from the European Union.

To contact the reporter on this story: Susanne Walker in New York at

To contact the editor responsible for this story: Dave Liedtka at

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