Demand Falters at Two-Year Treasury Auction as Fed Bets Mount

  • Fed's Yellen cites December meeting as `live possibility'
  • Wednesday note sale's bid-to-cover is lowest since 2010

Two-year Treasury yields reached the highest since 2011 as Federal Reserve Chair Janet Yellen said she sees the economy performing well, stoking speculation the central bank will raise its benchmark interest rate next month.

The Treasury’s sale of two-year notes on Wednesday drew the weakest demand for the issue since 2010. The results signal investors’ reluctance to hold the securities, the coupon maturity most sensitive to changes in Fed policy, weeks before the central bank may lift rates for the first time since 2006.

“You don’t need to be a conspiracy theorist to suggest that the risk of a rate hike should be negative for the very short-end auctions,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. The weak demand “makes sense because the Fed chairwoman just said this morning that a rate hike is on the table.”

Benchmark two-year yields rose five basis points, or 0.05 percentage point, to about 0.81 percent as of 5 p.m. in New York, reaching the highest since April 2011, according to Bloomberg Bond Trader data. The price of the 0.625 percent security due September 2017 fell almost 1/8, or $1.25 per $1,000 amount, to 99 5/8.

At the Treasury’s $26 billion auction of two-year notes Wednesday, the bid-to-cover ratio, which gauges demand, fell to 3.01, the lowest since 2010.

Speculation on the Fed’s path has buffeted Treasuries all year. Traders had mostly priced out a 2015 increase, only to ramp up those bets after policy makers said in their October policy meeting that they’d assess whether to boost borrowing costs in December.

Yellen in her Wednesday testimony to lawmakers in Washington said that a December rate move would be a "live possibility" as long as data support an increase. A private report Wednesday showed companies added 182,000 workers in October, signaling steady improvement in the economy.

Traders see a 56 percent chance the central bank will raise its benchmark rate at its next meeting, according to futures data compiled by Bloomberg. That’s the highest probability since Sept. 16, the day before the Fed’s policy statement that month. The calculation assumes the effective fed funds rate averages 0.375 percent after the first increase, compared with the current zero-to-0.25 percent target range.

‘On Notice’

The Wednesday employment statistics from the ADP Research Institute come two days before the government announces labor data. U.S. employers added 182,000 workers last month, after hiring 142,000 in September, according to a Bloomberg survey of economists before the Labor Department releases the data Nov. 6. After this week, the U.S. will issue one more employment report before the Fed’s Dec. 16 announcement on rates.

Also Wednesday, the Institute for Supply Management’s non-manufacturing index advanced to 59.1 from 56.9 the prior month as its measure of services employment advanced to the second-highest since August 2005.

"That’s a very strong number any way you cut it, and with the Fed having put the market on notice that December is certainly live and in play," said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. "I think that’s the main reason that the market’s selling off in the front end."

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