Treasuries Drop as 2-Year Sale Yield Almost Highest Since 2011

The Treasury’s auction of $32 billion of two-year notes drew a more-than-forecast yield that approached the highest since 2011 amid speculation the Federal Reserve will raise interest rates before the debt matures.

Benchmark 10-year notes erased losses on a report the U.S. is sending troops to Europe for military exercises in response to the Ukraine crisis. Today’s auction produced a yield of 0.447 percent, compared with a forecast of 0.442 percent in a Bloomberg News survey of seven of the Fed’s 22 primary dealers. Primary dealers were awarded 57.7 percent of the securities offered, the most since May 2013.

“The two-year note continues to cheapen and the long-end is leading us higher,” said Sean Murphy, a trader in New York at primary dealer Societe Generale SA. “The bit of uncertainty with overseas is creating a safe-haven type of bid.”

The benchmark 10-year yield dropped one basis point, or 0.01 percentage point, to 2.71 percent at 4:59 p.m. in New York, according to Bloomberg Bond Trader data. The price of the 2.75 percent note maturing in February 2024 traded at 100 10/32. The yield earlier reached the highest level since April 4.

The yield on the current two-year note added one basis point to 0.40 percent. The 30-year bond yield dropped three basis points to 3.50 percent. The difference between the yield on five-year notes and the 30-year bond narrowed to 1.76 percentage points, touching the lowest since October 2009.

Trading Pace

Treasury trading volume rose to $264 billion after dropping yesterday to $146 billion, the least since Dec. 27, according to ICAP Plc, the largest inter-dealer broker of U.S. government debt.

The two-year auction yield compared with 0.469 percent in March, the highest level since a sale in May 2011. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.35, compared with an average of 3.32 for the past 10 sales.

Indirect bidders, an investor class that includes foreign central banks, purchased 23.4 percent of the notes, compared with an average of 28.6 percent for the past 10 sales. Indirect bidders bought 40.9 percent of the securities at the March sale, the most since November 2011.

“It’s not what we would call a very good auction,” said Ray Remy, head of fixed income in New York at Daiwa Capital Markets America Inc., a primary dealer. “Dealers picked up an additional $6 billion from the month before.”

Debt Returns

Two-year notes have returned 0.3 percent this year, compared with an advance of 1.9 percent by the broad Treasuries market, according to Bank of America Merrill Lynch indexes. The two-year securities gained 0.3 percent in 2013, while Treasuries fell 3.4 percent.

Today’s offering is the first of three auctions of coupon-bearing debt this week. The Treasury will sell $35 billion of five-year securities tomorrow and $29 billion of seven-year notes the next day.

“A weak auction shows the market has lost some confidence in the Fed’s ability to clearly articulate its message,” said Thomas Simons, a government-debt economist in New York at Jefferies LLC, a primary dealer that is required to bid at the auctions, before the sale. “When the Fed will ultimately raise rates remains a big question.”

Fed Chair Janet Yellen signaled after the previous policy meeting on March 19 that the central bank may increase borrowing costs in the middle of next year, while this month she emphasized her commitment to support the recovery.

Fed Policy

The central bank has kept its target for overnight bank lending in a range of zero to 0.25 percent since December 2008. Policy makers next meet on April 29-30.

Futures prices put the likelihood the Fed will start raising rates in July 2015 at 72 percent yesterday, based on trading on the CME Group Inc.’s exchange. The chances for a raise increase in June 2015 fell to 49 percent, compared with 54 percent on April 4.

The Fed is in the process of phasing out quantitative easing, the bond-purchase program it has used to help support the economy. It purchased $1.02 billion in notes maturing between November 2039 and August 2043 today.

“The best thing for Treasuries is that quantitative easing is tapered,” said Stewart Taylor, a money manager who helps oversee $6.8 billion of Boston-based Eaton Vance Management’s $285.4 billion in global assets, in an interview yesterday on Bloomberg Radio with Kathleen Hays and Vonnie Quinn. Tapering “causes some sort of risk-off trade. That continues to support Treasuries.”

Ukraine Watch

The U.S. will send 600 troops from the Army’s 173rd Airborne Brigade Combat Team to four European nations for bilateral exercises this week, Rear Admiral John Kirby, a Pentagon spokesman, said today. The troops will be training for a month and are in response to the crisis in Ukraine.

The Bloomberg Global Developed Sovereign Bond Index has gained 3.4 percent this year, versus a 4.6 percent decline in 2013.

The negative outlook on the U.S.’s AAA credit-ranking was changed to stable by DBRS Inc. amid declining federal budget deficits and after Congress suspended the nation’s debt limit earlier this year until 2015.

The Toronto-based ratings company’s adjustment follows decisions by Moody’s Investors Service and Standard & Poor’s last year to change their outlooks on the U.S. to stable from negative. S&P stripped the nation of its top grade in August 2011, citing, in part, political discord about the debt limit. Moody’s gives the nation its top Aaa grade.

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