Treasury Inflation-Protected Securities tumbled after a record $18 billion auction of the notes attracted the lowest demand in more than four years with the economy showing few signs of rising consumer prices.
The five-year securities’ bid-to-cover ratio, a gauge of demand that compares the amount bid with the amount offered, was 2.2, the least since October 2008. Yields on benchmark 10-year notes traded at almost to the lowest level in four months. Three regional Federal Reserve bank presidents said a further decline in U.S. inflation below the Fed’s 2 percent goal may signal a need for more accommodation.
“The market seemed unprepared for the largest ever TIPS auction,” said Michael Pond, head of global inflation-linked research at Barclays Plc, one of 21 primary dealers that trade with the Fed. “Economic data has turned from a tailwind to a headwind and break-evens are just now catching up to fundamentals.”
The yield on the 0.125 percent security maturing in January 2023 rose eight basis points, or 0.08 percentage point, to negative 0.59 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The U.S. 10-year note yield declined one basis point to 1.68 percent after touching 1.67 percent yesterday, the lowest since December.
The break-even rate, or the difference between the yield and that on 10-year notes that investors use as a gauge of inflation over the life of the securities, fell nine basis points to 2.27 percent, the biggest decline since November 2011. The break-even rate on the current five-year TIPS fell 13 basis points to 1.94 percent.
“We’re looking at buying right now -- the break-evens have been coming down,” said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management. The firm oversees $15 billion in assets. “The market has got momentum to the downside so we’re trying to be smart about it.”
Treasury volatility as measured by Bank of America Merrill Lynch’s MOVE index was at 51.31 basis points as of 4:09 p.m. today, the lowest level since Dec. 3, when it closed at a record 51 basis points. The gauge, which tracks the outlook for swings in U.S. government debt rates, has averaged 63.6 basis points in the past year.
The five-year TIPS sale drew a yield of negative 1.311 percent versus a forecast of negative 1.384 percent, according to the average in a Bloomberg News survey of six of the Federal Reserve’s 21 primary dealers. The bid-to-cover ratio fell from versus 2.7 at the last auction in December and 2.8 average averaged over the previous 10 sales.
Indirect bidders, a class of investors that includes foreign central banks, purchased 46.1 percent of the securities versus 49 percent at December’s auction, the most since October 2006. The average for the prior 10 offerings was 39.2 percent.
Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 7.8 percent, the lowest since April 2011, after buying 10.7 percent at the December and average of 8.2 percent at the past 10 auctions.
Treasury Inflation Protected Securities are lagging behind traditional U.S. securities in 2013 for the first time in five years. TIPS investors have gained 0.2 percent since Dec. 31, while nominal debt has returned 0.6 percent, according to Bank of America Merrill Lynch indexes. That puts the index-linked securities on course for the first underperformance since 2008, when they lost 1.1 percent while Treasuries climbed 14 percent.
“TIPs have had a rough time recently with the commodities selloff and renewed fears of deflation,” said Jason Rogan, director of U.S. government trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “People are again more concerned about deflation than they are about inflation. When that occurs, it will affect this market.”
Firms from U.S. Bancorp to Federated Investments that had been buying government securities that protect against rising consumer prices during the Fed’s recent efforts to inject cash into the economy are now selling on the behalf of clients. For the first time since the depths of the financial crisis in 2008, mutual funds that target Treasury Inflation-Protected Securities have seen outflows for three straight months, according to Morningstar Inc.
The U.S. will sell $99 billion in nominal notes next week: $35 billion in two-year debt on April 23, the same amount of five-year securities the next day and $29 billion in seven-year notes on April 25.
“If inflation looked like it was going to sag further on a persistent basis, I would certainly consider stimulus for the purpose of bringing inflation up to target,” Richmond Fed President Jeffrey Lacker, a critic of current easing, said today.
Minneapolis Fed President Narayana Kocherlakota today called for guarding the inflation target “from below,” while James Bullard of St. Louis said yesterday, “we should defend the inflation target from the low side.”
The Fed bought $3.378 billion of securities due from May 2020 to February 2023 today as part of its program known as quantitative easing, in which it is purchasing $85 billion of government and mortgage debt a month to spur growth and boost employment.
Treasuries rose earlier as manufacturing data and an index of leading economic indicators trailed forecasts.
“The economy is weakening going into the summer -- it’s tilting back toward zero percent growth, and that will keep the Fed continuing to do what they do,” said Charles Comiskey, head of Treasury trading in New York at primary dealer Bank of Nova Scotia.