Yields jump as traders fear weak 7-year auction

By Karen Brettell

NEW YORK (BestGrowthStock) – U.S. Treasuries prices fell broadly on Tuesday and some maturities were on track for their worst monthly performance in years after an auction of 5-year notes drew dismal demand.

Sellers drove yields up to levels that may spark stronger interest in the sale of $29 billion in seven-year notes set for Thursday.

Bond yields have soared this month on expectations that 2011 will see accelerating economic growth, while concerns over the U.S. deficit have also weighed on the debt. The surge in borrowing costs will make it even more expensive for the U.S. Treasury to sell record amounts of debt as the economy battles to exit a deep recession.

“It was a sloppy auction. It came behind where it was trading at the time of the auction. The bid-to-cover ratio was low compared to the previous auction, and foreign participation was light,” said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co in Seattle.

Dealers took more than half of Tuesday’s $35 billion auction. It was the second day in a row that dealers took the majority of the notes, buying 58 percent, following a sale of two-year notes on Monday.

The high yield of the auction was 2.15 percent, which is 4.65 basis points higher than where current issues were trading at the time of the auction.

This five-year auction had the largest tail and the highest allocation taken by dealers since July 2009, Morgan Stanley analysts said in a report.

Bill Gross, the co-chief investment officer of PIMCO, called the auction “a stinker” and said it “shows the problems the U.S. is encountering in terms of the deficit situation,” in an interview on CNBC.

Five-year notes, which have risen 0.70 percent in yield this month, are facing their weakest month since April 2004.

Seven-year notes are also having their worst month since the Treasury began issuing the notes in Spring 2009, with their yields rising 0.68 percent.

SEVEN-YEAR SALE RISKS WEAKNESS

The poor results bode badly for Wednesday’s auction, though higher yields may attract buyers.

“I think this means you need more of a concession, and you’re getting it,” said Richard Gilhooly, interest rate strategist at TD Securities in New York.

Seven-year notes were last down 31/32 in price to yield 2.88 percent, up from 2.72 percent late Monday.

The notes traded at yields of 2.91 percent in the “when-issued” market, which indicates where traders expect the new debt to price.

Five-year notes fell 18/32 in price to yield 2.16 percent, up from 2.02 percent late on Monday. Benchmark 10-year notes dropped 1-8/32 in price to yield 3.49 percent, up from 3.33 percent.

Thirty-year bonds also dropped 2-8/32 to yield 4.54 percent, up from 4.40 percent on Monday.

In spite of the generally weak performance, Tuesday’s auction was likely positive for dealers, who would have benefited from buying back debt at higher yields than where they had earlier shorted, said Gilhooly.

“This is a good auction for the dealers. Yesterday they ended up paying aggressively for the 2-year auction; they paid more than where they shorted,” he said.

Dealers typically short Treasuries the morning before an auction and then repurchase the debt during the sale.

Gilhooly views intermediate-dated Treasuries as oversold and recommends taking long positions in the “belly” of the curve relative to shorter- and longer-dated maturities.

These notes will benefit after Wednesday’s auction as dealers are then likely to set up for sales of three-year, 10-year and 30-year bonds, which are scheduled for early January, he said.

(Additional reporting by Wanfeng Zhou; Editing by Dan Grebler)

Yields jump as traders fear weak 7-year auction