Brian Edmonds Comments: Short-Term Treasurys Up After Drop In Durable Goods; Auction Looms

July 28, 2010, The Wall Street Journal

Short-term Treasury prices rose modestly Wednesday after data that showed an unexpected drop in U.S. durable goods orders last month, adding to fears about the economic outlook.

The report prompted nervous investors to move into low-risk Treasurys and out of riskier assets, such as stocks. Gains, however, were limited ahead of the key event of the day for the bond market, the government's second note sale of the week, an offering of $37 billion in five-year notes.

In recent trade, the two-year Treasury was up 1/32 to yield 0.645%, the five-year was 2/32 higher to yield 1.777% and the 10-year was up 2/32 to yield 3.039%. The 30-year was off 2/32 to yield 4.085%.

"People were looking for a little more strength out of durable goods," said Brian Edmonds, head of interest rates at Cantor Fitzgerald & Co. in New York. "The onus is on the economic numbers to prove the economy is stronger than expected," he said, given the widely held view now that the economy could falter in the second half of the year.

Data showed that demand for U.S. manufactured durable goods slid in June for a second consecutive month in another sign the manufacturing sector expansion is slowing. Durable-goods orders fell by 1.0% to a seasonally adjusted $190.5 billion. Economists surveyed by Dow Jones expected a 1.1% gain.

The report adds to other recent weaker data, including soft readings on consumer confidence, slower growth in the manufacturing sector and a still struggling labor market. Market participants will get the latest take on the jobs market in the U.S. next week with the July payrolls report.

For Treasurys, the key event of the day Wednesday will be the government's five-year auction, which will follow a well bid two-year sale on Tuesday. The two-year notes were sold at the lowest yield on record, a sign of the strong continued demand for Treasurys given the uncertain economic outlook, and good news for the government as it continues to auction off massive amounts of debt.

The $37 billion five-year sale--the smallest issue since June 2009--will be helped by the fact that the five-year yield has backed up considerably over the last week. Wednesday morning the five-year yield was about 15 basis points lower then its recent low of 1.626% hit a week ago.

"We've backed up enough that there will be demand," Edmonds said.

The sale, however, could be a bit trickier than the two-year auction, despite the yield back up. In past series of twos, fives and sevens, twos and seven-year sales have drawn good demand, while recent five-year auctions have tailed, meaning the government had to pay up to sell the notes. Two-year notes are popular as demand for front-end Treasurys remains strong with the Fed on hold for a while. Seven-years are an issue that have been popular with foreign investors as it allows them to pick up a bit more yield.

The last five-year sale was 2.58 times subscribed, indirect bidders, domestic and foreign institutions, including foreign central banks, took 34.6% of the notes and directs 10.7%. At the last four five-year auctions, the bid to cover was 2.65, indirect bid 41% and direct 12.7%.

Edmonds said that the large number of direct bidders of late have "spooked the dealers somewhat," with primary dealers--firms that deal directly with the Federal Reserve and underwrite Treasury auctions--reducing their participation a bit given the direct bid wildcard.

Traders Wednesday pointed to thin summer trading, noting Treasurys will likely be watching equities until the auction this afternoon. After the auction, market participants will be keen to see the Federal Reserve's beige book, its report on economic conditions from the regional Federal Reserve banks, which forms the basis for policy makers deliberations when they gather for their next rate-setting meeting.

The June beige book showed the majority of regions reporting expansions, 10 out of 12, but was accompanied by reports of slowing activity from Chicago and St. Louis. An increase in the number of regions with declines or worsening labor market anecdotes is the consensus for Wednesday's report.