Treasuries Fluctuate Before U.S. Auctions $32 Billion

Treasuries fluctuated amid concern almost record holdings of U.S. government debt maturing in three years and less by Wall Street firms may diminish the haven appeal of three-year notes at today’s $32 billion auction.

Yields on benchmark 10-year note fell to less than 0.1 percentage point from all-time lows as Bank of England Governor Mervyn King’s comments that the U.K. economy doesn’t show “great signs” of recovering from recession underscored the refuge aspect of U.S. securities. The three-year notes traded at a yield of 0.367 percent before the sale, just above the record low level set at the September auction.

“Dealer positioning is really long in the three-year sector as domestic buyers haven’t been buying a lot and the Fed is selling a lot of positions in that sector, which may weigh against demand some,” said Scott Sherman, an interest-rate strategist in New York at Credit Suisse Group AG, one of 21 primary dealers that trade with the Fed. “But given the headwinds in the economy, and with the Fed still on hold, the auctions should be fine.”

Ten-year note yields were little changed at 1.51 percent at 11:33 a.m. New York time, according to Bloomberg Bond Trader data. The all-time low was 1.44 percent set June 1. Yields fell 12 basis points in the past three days. The 1.75 percent security due May 2022, fell 1/32, or 31 cents per $1,000 face amount, to 102 5/16.

Primary dealer net outright position in U.S. government securities due in three years or less is at of $61.5 billion, down from a high of $73.2 billion in June, according to Federal Reserve data. The average over the past year is $34.5 billion.

Butterfly Chart

A butterfly-chart spread indicates the Treasury three-year note may outperform two- and five-year securities as it approaches the cheapest level since May 2009 before the Federal Open Market Committee meets next week.

The index spread, which measures how the three-year note is performing against the other two securities, is about negative 18 basis points, the cheapest level since May 2009. An advance toward positive figures indicates investors are more bearish on the middle of the three securities, making it relatively cheap versus the others.

The Treasury Department is selling $21 billion of 10-year debt tomorrow and $13 billion of 30-year bonds on July 12.

“The domestic economy has shown no signs of emerging from the recent soft patch that we have been in, and Europe continues to be a constant motivator of demand for Treasuries, keeping yields low,”said Thomas Simons, a government-debt economist in New York at Jefferies Group Inc., a primary dealer. “Politicians move slower than any of us thought they would, and that just prolongs the uncertainty, keeping fear constant and rates low.”

Notes Auction

Three-year notes yielded 0.359 percent in pre-auction trading, versus 0.387 percent the last time the notes were sold on June 12.

Investors submitted orders for 3.53 times the amount of available debt last month. The average over for the past 10 sales is 3.45.

Direct bidders, non-primary dealers buying for their own accounts, purchased 12 percent of the notes, the most since November. Indirect bidders, which include foreign central banks, bought 27 percent of the securities, the least since May 2007.

Treasury trading volume reported yesterday by ICAP Plc, the largest inter-dealer broker of U.S. government debt, dropped to $146.3 billion, compared with a 2012 average of $242.2 billion.

The 10-year Treasury futures contract for September delivery was little changed at 134 15/32 after reaching an all-time high of 134 30/32 on June 1.

‘Bullish Development’

The contract may rise to a fresh record should the price remain above a level of so-called support, Richard Adcock, head of fixed-income technical strategy in London at UBS AG, a primary dealer, wrote in an e-mailed note to clients today.

A break above yesterday’s 134 5/8 high “will be the next bullish development, opening the door first to 134 30/32, then the extension level at 135 13/32,” he wrote, citing Fibonacci levels.

Support refers to an area on a graph where buy orders may be grouped. Fibonacci analysis is based on the theory that prices rise or fall by certain percentages after reaching a high or low.

The Fed is scheduled to buy as much as $1.5 billion of Treasury Inflation Protected Securities due from July 2018 to February 2042 today, according to the Fed Bank of New York website, part of its plan to extend the maturity of its holdings.

‘Limited Amount’

Fed Bank of St. Louis President James Bullard said the U.S. central bank shouldn’t expand Operation Twist after the end of 2012.

“There’s a limited amount of short-term treasuries we can sell and buy long-term treasuries, so I don’t think we can look at any extension of twist beyond the end of the year,” Bullard told reporters in London today. “We’re running out of balance sheet.”

Money managers have been willing to buy conventional bonds because of forecasts that inflation will stay in check, which would make it easier for the Fed to increase its bond purchases to fuel the economy.

The difference between yields on 10-year notes and same-maturity TIPS, a gauge of trader expectations for consumer prices over the life of the debt, has narrowed to 2.08 percentage points from this year’s high of 2.45 percentage points on March 20. The average over the past decade is 2.15 percentage points.

Producer Prices

Labor Department figures due on July 13 will show the U.S. producer price index slid for a third month in June with a 0.4 percent decline, according to the median estimate of economists surveyed by Bloomberg. Consumer prices were unchanged, after falling 0.3 percent in May, a separate survey of economists forecast before the July 17 report.

“The liquidity has been light over the last few days,” said Justin Lederer, an interest-rate strategist in New York at Cantor Fitzgerald LP, a primary dealer. “It’s the continued risk-on, risk-off. If we get weak data, we could approach record low yields.”

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