Treasuries Draw Weakest Demand Since ‘08 at Auction as Fed Looms

  • Two-year sale kicks off week’s $103 billion of coupon auctions
  • Fed to keep door open for one 2016 hike: Credit Agricole

The Treasury’s auction of two-year notes lured the weakest demand since 2008 as bond traders bet Federal Reserve policy makers this week will acknowledge signs of economic strength, bolstering the case for an interest-rate increase this year.

Benchmark two-year yields set a one-month high as the Treasury sold $26 billion of the maturity at steeper yields than indicated in pre-auction trading. A gauge of demand known as the bid-to-cover ratio was 2.52, the weakest at a two-year U.S. offering since December 2008. What’s more, Wall Street dealers were stuck with the highest share of a two-year sale since 2013.

Buyers’ appetite waned as global financial markets have largely overcome the U.K.’s vote to leave the European Union. Economic readings, including U.S. labor data, have pointed to strength. The Citigroup Inc. U.S. Economic Surprise Index, which measures whether data beat or miss analyst forecasts, reached the highest since 2014.

Results from the auction “suggest quite a bit of weakness, which partly highlights the uncertainty from the Fed,” said Aaron Kohli, a fixed-income strategist in New York at BMO Capital Markets, one of the 23 primary dealers that trade with Fed.

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The U.S. is the latest country to face ebbing investor interest in the face of near-record-low yields, with about $10 trillion of sovereign debt worldwide yielding less than zero. Demand at Australia’s bond sales this year has dropped to the lowest since 2002, while an auction this month of German five-year securities had the smallest bid-to-cover since 2011.

Treasury 10-year note yields rose less than one basis point, or 0.01 percentage point, to 1.57 percent at 5 p.m. in New York, according to Bloomberg Bond Trader data. The price of the 1.625 percent security due in May 2026 was 100 15/32. The yield dropped to a record 1.318 percent on July 6.

Two-year U.S. yields increased three basis points to 0.73 percent. Monday’s sale is the first of $103 billion of coupon-bearing government-debt auctions scheduled for this week.

Fading Frenzy

The results of Monday’s sale indicate that the feeding frenzy for government debt may be losing steam. Ten-year yields, the benchmark for everything from U.S. mortgages to dollar bonds in developing nations, dropped to a record this month as investors sought alternatives to negative interest rates in Europe and Japan. The Fed will keep its benchmark rate unchanged when it meets Tuesday and Wednesday, based on a Bloomberg survey of economists.

The implied probability that the Fed will raise rates by year-end rose to about 48 percent Monday, the highest in about a month, according to futures data compiled by Bloomberg. Futures reflect about a 10 percent chance of an increase at the July 26-27 meeting. It jumps to a 26 percent likelihood for September.

“If the data later this week do support a September hike, the part of the curve that’s really going to get hit the hardest is the two- and three-year part of the curve,” Kohli said. Shorter maturities are more sensitive to changes in expectations for Fed policy.

Even if the Fed raises rates this year, it will be a change from expectations heading into 2016. For a time after the December liftoff from near zero, policy makers had envisioned four quarter-point increases this year.

“The Fed is likely to keep the door open for one hike this year,” said Mohit Kumar, head of rates strategy at Credit Agricole SA’s corporate and investment-banking unit in London. “If the data continues to be strong, they should be in a position to hike this year. I’m looking for them to be less dovish than the market is pricing in now. Supply will also weigh on Treasuries.”

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