Weak U.S. Note Sale Leaves Fed’s Dealers Biggest Share

The U.S. sold $32 billion of two-year notes at a higher-than-forecast yield, leaving the Federal Reserve’s primary dealers, which are obliged to bid in Treasury sales, with their biggest share of the auction in almost a year.

The notes yielded 0.447 percent at yesterday’s sale, the second-highest level since the May 2011 monthly auction drew 0.56 percent. The average forecast of seven of the 22 primary dealers in a Bloomberg poll was 0.442 percent. Primary dealers bought 57.7 percent of the securities, the most since May 2013.

“Two-year notes have outperformed this year, and with the economy picking up in the spring, the securities are not cheap any more, causing the auction to come in weaker than expected,” said Aaron Kohli, an interest-rate strategist at the primary dealer BNP Paribas SA in New York. “We didn’t see real investor demand at these levels. There needs to be more risk premium priced in.”

The yield on the current two-year note rose one basis point, or 0.01 percentage point, to 0.40 percent at 5 p.m. yesterday in New York, according to Bloomberg Bond Trader Prices. It increased four basis points last week, the most in a month. Benchmark 10-year note yields were little changed at 2.71 percent.

Fed Chair Janet Yellen rattled investors on March 19 after a policy meeting by signaling the benchmark interest-rate target, which has been virtually zero since 2008, may be raised in mid-2015. This month, she emphasized her commitment to support the recovery.

Fewer Bets

Futures prices show bets on an early increase have eased, indicating a 12 percent chance the Fed will raise rates by January, versus odds of 17 percent a month ago.

“Despite a moderation in an earlier-than-expected Fed rate hike, there remains enough uncertainty that the two-year auction was met with soft demand,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York. “The market seems content to be taking a wait-and-see approach and not over committing to either an early 2015 or a late 2015 hike.”

Policy makers have kept the rate target for overnight loans between banks at zero to 0.25 percent since December 2008. The central bank has reduced monthly bond-buying under its quantitative-easing stimulus strategy to $55 billion, from $85 billion last year, and has promised further “measured steps” if the economy continues to improve. The Fed buys the debt to hold down borrowing costs and fuel economic growth.

Bidder Participation

At the auction, indirect bidders, a category of investors that includes foreign central banks, bought 23.4 percent of the notes at the sale, the lowest level since December. They purchased 40.9 percent at the March sale, the highest since November 2011.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 19 percent of the notes. That compares with an average of 22.4 percent at the past 10 offerings.

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.

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 overall fell 3.4 percent.

Yesterday’s sale was the first of three auctions of coupon-bearing debt this week. The Treasury will sell $35 billion of five-year securities today and $29 billion of seven-year notes tomorrow.

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