Treasuries Drop as U.S. Sells $35 Billion in 5-Year Notes

September 24, 2014

Washington (Sept 24)  Treasuries fell for the first time in five days as the U.S. received the lowest demand at a five-year note auction this year with investors speculating the Federal Reserve is moving closer to raising interest rates.

The $35 billion sale’s bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.56, the lowest since December and versus an average of 2.75 for the past 10 sales. The Fed’s 22 primary dealers were left with 41 percent of the notes, the most since January. Government securities headed for the steepest monthly loss this year after central-bank officials raised their median forecast for borrowing costs.

“The weak auction is reflecting a market that realizes that we are at a crossroads -- the Fed seems on course to raise rates,” said Carl Lantz, head of interest-rate strategy in New York at Credit Suisse Group AG, which as a primary dealer is obligated to bid at U.S. auctions. “The market is finally starting to trade with that in mind, and it’s clear that time isn’t on your side anymore.”

The benchmark Treasury 10-year yield rose four basis points, or 0.04 percentage point, to 2.57 percent as of 3:21 p.m. New York time after dropping nine basis points the previous four days, according to Bloomberg Bond Trader prices. The 2.375 percent note maturing in August 2024 fell 10/32, or $3.13 per $1,000 face value, to 98 11/32.

Current five-year note yields gained four basis points to 1.80 percent.

5-Year Sale

Today’s auction was rated a “two” on a scale of one through five, with one being failed, by six of the Fed’s dealers. The securities yielded 1.8 percent, the highest since May 2011 and the same as the forecast in a Bloomberg News survey of six primary dealers.

“It was a fairly weak auction that left dealers having to take down a lot,” said Jason Rogan, managing director of U.S. government trading at Guggenheim Securities, a New York-based brokerage for institutional investors.

Indirect bidders, an investor class that includes foreign central banks, purchased 50.3 percent of the notes, compared with an average of 47.1 percent for the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 8.8 percent of the notes, the least since July 2013 and versus an average of 14.1 percent for the past 10 auctions.

Notes ‘Punished’

Five-year notes have returned 1.7 percent this year, versus a gain of 3.5 percent by the broad Treasuries market, according to Bank of America Merrill Lynch indexes. The five-year securities lost 2.4 percent in 2013, while Treasuries overall fell 3.4 percent.

“The five-year note has been punished because of the change of tone at the Fed,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas, another primary dealer. “The fear is that the Federal Open Market Committee will be much more aggressive once they start. And, if you believe they will act, the five-year note will suffer the most.”

Fed policy makers meeting on Sept. 16-17 boosted their median estimate for the benchmark interest rate, which banks charge each other on overnight loans, for the end of 2015 to 1.375 percent, compared with 1.125 percent in June.

Policy makers have also said they may end the central bank’s purchases of Treasury and mortgage debt in October, concluding the program known as quantitative easing the Fed has used to support the economy.

Fed Debate

Even so, officials are giving conflicting opinions on the future path of interests rates.

Speaking at an event in Cheyenne, Wyoming, yesterday, Kansas City Fed President Esther George said now is the time to start normalizing rates. Fed Bank of New York President William Dudley argued on Sept. 22 at the Bloomberg Markets Most Influential Summit in New York for “patience” on interest-rate increases, cautioning that “if the dollar were to strengthen a lot, it would have consequences for growth.”

The risk of tighter Fed monetary policy has helped the dollar appreciate this quarter against all 16 of its major peers tracked by Bloomberg. That’s transformed losses into gains for foreign holders of U.S. Treasuries, who own $6 trillion worth.

“If you have a positive view on the U.S. dollar, you may buy bonds to take advantage of that,” said Allan von Mehren, chief analyst at Danske Bank A/S in Copenhagen. “We are moving closer to beginning rate normalization and the market is still softly priced for that.”

Monthly Decline

Treasuries have fallen 0.8 percent this month through yesterday, set for the biggest decline since December, Bloomberg World Bond Indexes (BUSY) show. They have returned 3.7 percent this year, compared with 6.1 percent for investment-grade corporate bonds and 5 percent for mortgage-backed securities, the data show.

At yesterday’s sale of two-year notes, indirect bidders, a class of investors that includes foreign central banks, purchased 40.9 percent of the notes, matching the most since November 2011.

The U.S. will sell $29 billion of seven-year fixed-rate securities tomorrow.

The Treasury also sold $13 billion of two-year floating-rate notes today at a high discount margin of 0.041 percent, compared to 0.055 percent last month. The securities drew bids for 4.45 times the amount available, versus 4.38 last month and a 4.73 average over the eight offerings of the notes since they were introduced in January.

Source:  Bloomberg

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