Treasuries Drop as Auction Draws 10-Month High Yield Before Fed

Treasuries fell for a fourth day as the U.S. sold $35 billion of five-year notes at the highest yield since March amid concern the Federal Reserve may provide guidance tomorrow on when it will slow bond purchases.

Benchmark 10-year notes yielded 2 percent for a second day, the highest level since April, amid better-than-forecast economic data. The five-year notes drew a yield of 0.889 percent, versus an average forecast of 0.887 percent in a Bloomberg News survey of seven of the Fed’s primary dealers. Investors increased bets to the highest level since 2011 that the price of Treasuries will drop, a JPMorgan Chase & Co. surveyed showed. Trading in options that profit if Treasury yields rise surged yesterday to the highest since 2007.

“There’s a shift in sentiment on where the next level is in the marketplace,” said Scott Graham, head of government bond trading at Bank of Montreal’s BMO Capital Markets unit in Chicago, one of the 21 primary dealers required to bid at U.S. debt auctions. “This 2 percent level will be a meaningful buy level for accounts.”

The 10-year note yield rose four basis points, or 0.04 percentage point, to 2 percent at 5 p.m. in New York, according to Bloomberg Bond Trader prices. The price of the 1.625 percent security due in November 2022 fell 10/32, or $3.13 per $1,000 face value, to 96 21/32. The yield climbed to 2.004 percent yesterday, the highest since April 18.

The current five-year note rose 2 basis points to 0.88 percent.

Foreign Bid

Trading in options that profit if yields rise surged yesterday to the most in more than five years. About 73.9 percent of the volume in options on all Treasury note futures was in puts, the highest level since June 8, 2007, according to data from CME Group Inc., the world’s largest futures exchange. Puts gain in value if the underlying futures price falls.

At today’s five-year note sale, the bid-to-cover ratio, which gauges demand by comparing total bids with the amount of notes offered, was 2.88 at today’s auction, versus 2.72 last month and an average of 2.86 at the past 10 sales.

“The big selloff brought only modest buying to the most important auction of the week -- the street had been optimistic, but that optimism was misplaced,” Jim Vogel, an interest-rate strategist at FTN Financial, said in a telephone interview from Memphis, Tennessee. “To bring in size-buying at risk requires some cheaper yields, at least until the Fed speaks tomorrow.”

Indirect bidders, an investor class that includes foreign central banks, purchased 39.7 percent of the notes, compared with an average of 41.2 percent at the past 10 sales. They bought 32.4 percent of the notes at the December auction.

Market Losses

Direct bidders, non-primary dealer investors that place their bids directly with the Treasury, purchased 16.8 percent of the notes, after buying 30.4 percent of the notes in December, the highest since Sept. 2004. That compares with the 10-auction average of 12.7 percent.

U.S. five-year Treasury notes have fallen 0.77 percent this year, compared with 0.95 percent loss for the broader Treasury market, according to Bank of America Merrill Lynch.

The U.S. sold $35 billion of two-year notes yesterday and will auction $29 billion of seven-year securities tomorrow.

Central-bank policy makers said at their last meeting they may end purchases of government securities sometime in 2013, with members divided between a mid- or end-of-year finish, according to the minutes of the Federal Open Market Committee’s Dec. 11-12 gathering.

Short Bets

“Bernanke may clarify that they are committed to QE --that sets the stage for stability and a move lower in rates,” said Rajiv Setia, head of U.S. rates research in New York at Barclays Plc. “The selloff is an attractive buying opportunity. Our target for year-end is 1.60 percent. We think this is a good opportunity to buy the dip.”

Investors raised bets to the highest level since July 5, 2011, that the price of the securities will drop, according to JPMorgan.

The percentage of shorts in the firm’s “all clients” survey rose to 25 percent in the week ending yesterday, up from 19 percent the previous week. Longs, or bets Treasuries will rise, increased to 13 percent from 7 percent the previous week.

The proportion of net shorts remained steady at 12 percentage points, according to JPMorgan. About 62 percent of the clients surveyed were neutral, down from 74 percent.

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