Weight of U.S. bond supply just starting to strain

By Burton Frierson – Analysis

NEW YORK (BestGrowthStock) – The worst might be over for the growth in U.S. government debt auctions, but the effects of the burgeoning bond supply may have only just begun if the economy keeps improving.

The government will illustrate this on Thursday when it announces mostly unchanged auction sizes for next week’s more than $80 billion in bond sales, which nevertheless may require the highest yields in nine months to attract bidders.

The growing U.S. debt has cast a shadow over bonds for months, but bidders have only recently shown signs of weariness, with market disruptions and rising economic optimism contributing to dreadful Treasury auctions last week.

The trouble will only intensify if predictions come true of a strong payrolls report on Friday.

Ironically, the downturn in bond sentiment comes despite expectations the government might announce reductions in issues as early as May.

“It does feel like we’re getting to the point where supply is starting to bind,” said Carl Lantz, U.S. interest rate strategist at Credit Suisse in New York.

“The good news on that front is supply has probably peaked, and the next big change in issuance will be to go to lower levels. It will probably be at the May refunding or maybe one of the subsequent reopenings, but I do think it is kind of a mid-year event.”

The government will announce on Thursday sizes of next week’s three-, 10- and 30-year bond sales as well as 10-year Treasury Inflation Protection Securities, with the total expected at $81 billion to $82 billion.

Except for the three-year notes, the sales are reopenings of previously issued debt, which often draw lower demand.

WATCHING CLOSELY

Closely watched will be the 10-year issue, the market’s benchmark. The 30-year sale will also attract attention because it gauges investors’ concerns over long-term inflation.

The two maturities posted stellar auction results earlier in March but may fall victim to the bond market anxieties that punished last week’s offerings of shorter dated debt.

The result was a bond-market rout that pushed yields on 10-year and 30-year bonds to nine-month highs of 3.93 percent and 4.80 percent, respectively, in the last week.

Though analysts are still debating the cause of that sell-off, the worries it created will require loftier yields to get next week’s offerings taken down.

“I think 4.0 percent in 10-year notes is kind of the line in the sand that will see increased demand,” said Jeff Feigenwinter, director of U.S. Treasury trading at BNP Paribas in New York.

“In 30s, if you should approach 5.0 percent, I think you’ll see increased demand.”

Lantz, at Credit Suisse, said 3.90 to 4.0 percent in 10-year yields should draw bidders, and 4.85 percent in 30-year yields would be attractive.

Analysts expect the issue of new three-year notes to stay at $40 billion. The 10-year reopening is expected to remain at $21 billion and the 30-year bond reopening to be unchanged at $13 billion.

The TIPS sale might be a candidate for a $1 billion increase because Treasury has targeted this area for expansion. The last 10-year TIPS reopening, in October, was $7 billion.

WHY NOW?

Though the recent sell-off has taken place against the backdrop of improving economic data, technical issues last week also contributed to the losses, dealers said.

Benchmark 10-year notes started trading at a discount to private sector credit in the interest rate swap market.

While supply, among many other factors, could have resulted in that move, it ultimately forced selling by traders who were betting against it, exacerbating the losses.

Also, the month’s end coincided with the fiscal year-end in Japan, potentially keeping one of the top two buyers of U.S. government debt sidelined.

Friday’s payrolls report may help clear the air, boosting safe-haven Treasuries on unexpectedly weak data. A strong report, however, would lift risky assets such as stocks but add another note of misery to the bond auctions.

“We’ve already been swamped with debt,” said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco.

“If the economy is bouncing back in a little better fashion than the fairly sluggish pace we’ve seen this quarter, that takes further demand out of bonds.”

Stock Market Today

(Editing by Padraic Cassidy)

Weight of U.S. bond supply just starting to strain