Treasuries Drop as Record Low Yield Saps Two-Year Auction Demand

Treasury two-year note yields increased the most since April as speculation Greece’s lawmakers will approve austerity measures reduced demand at the U.S. government’s $35 billion auction of the securities.

Indirect bidders, an investor class that includes foreign central banks, purchased 22 percent of the notes, the lowest in more than three years. Thirty-year bonds were the worst performing Treasuries, increasing the difference in yields with two-year securities to the widest since March.

“A lot of people weren’t prepared for a bad two-year auction,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. “Now it’s all hands on deck for tomorrow to see if we’re going to get hit again with a bad five-year note auction. I guess rates really do matter to the average investor.”

Yields on current two-year notes gained seven basis points, or 0.07 percentage point, to 0.39 percent at 5:20 p.m. in New York, according to Bloomberg Bond Trader prices. The 0.5 percent security maturing in May 2013 fell 1/8, or $1.25 per $1,000 face amount, to 100 6/32.

The two-year note yields advanced the most on an intraday basis since April 27, when the Federal Reserve said it would complete its $600 billion program of debt buying on schedule at the end of June. The yields fell on June 24 to 0.32 percent, the lowest level since Nov. 4, the day after the central bank said it would resume buying debt.

Long Bonds

Yields on 30-year bonds climbed 11 basis points to 4.3 percent, the highest level since June 15. The extra yield investors demand to hold 30-year bonds instead of two-year notes increased to 3.90 percentage points, the widest since March 14.

Four-week bill rates traded negative today for the first time in more than a year on quarter-end buying amid a shrinking supply of the securities. The rates decreased to negative 0.005 percent, the lowest level since January 2010. The rates reached a record negative 0.09 percent on Dec. 4, 2008.

At today’s note auction, the securities produced a record low yield of 0.395 percent, compared with the average forecast of 0.386 percent in a Bloomberg News survey of eight of the 20 primary dealers obliged to participate in U.S. debt offerings. The previous record low yield for an auction of this size is 0.4 percent, attained Oct. 26.

The bid-to-cover ratio, which gauges demand by comparing total bids with amount of securities offered, was 3.08, compared with 3.46 last month and an average of 3.39 at the past 10 government debt offerings.

Indirect Bidders

Indirect bidders purchased 22 percent of the notes, the lowest since February 2008 and down from 31.3 percent in May. Direct bidders, non-primary dealer investors that place their bids directly with the Treasury, purchased 13.5 percent of the notes, compared with 19.1 percent last month and an average of 14.1 percent at the last 10 auctions.

“It doesn’t look like it was a tremendous auction,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors. “We were probably a little overdone last week on the flight-to-quality bid.”

The Treasury Department is scheduled to auction $35 billion in five-year debt tomorrow and offer $29 billion of seven-year notes on June 29.

Bonds dropped earlier today as the German government welcomed proposals from French banks and insurers on voluntary participation in a roll-over of Greek debt.

Sarkozy on Greece

At a press conference in Paris, President Nicolas Sarkozy said French banks and insurers proposed rolling over 70 percent of their holdings of Greek debt.

Greek lawmakers begin a three-day debate today on the 78 billion euro ($111 billion) austerity measures, with a vote expected to be on June 29. Failure to pass the plan may lead to the euro area’s first sovereign default.

“Even though the vote will be tough, the market still thinks it will go through,” Wunderlich’s Franzese said. “The world’s not coming to an end.”

The Fed purchased $4.578 billion of securities maturing from June 2015 to September 2016 today as part of its program of debt buying.

The central bank said on June 22 that it will continue to buy Treasuries with proceeds from the maturing debt it currently owns. That could mean purchases of as much as $300 billion of government debt over the next 12 months without adding money to the financial system.

U.S. consumer spending unexpectedly stagnated in May after an increase of 0.3 percent in the previous month, the Commerce Department reported. The median forecast of 70 economists in a Bloomberg News survey was for a 0.1 percent increase.

Fed Speaker

Minneapolis Fed President Narayana Kocherlakota urged Congress today in a speech in Big Sky, Montana, to change the nation’s tax system in a way that discourages banks and households from accumulating debt.

“The U.S. tax system encourages leverage by providing incentives for households to take on more mortgage debt and financial institutions to finance through debt,” Kocherlakota said. It does so “even though both are potentially destabilizing,” he said.

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