Brian Edmonds Comments: Treasurys Rise As Fed Buying Plan Trumps Stock Rally, Auction
October 13, 2010, The Wall Street Journal
The Treasury market rallied Wednesday, rebounding from earlier losses, as investors took heart from the Federal Reserve's announcement to buy $32 billion in government bonds in the next few weeks.
As of 3:58 p.m. EDT, the benchmark 10-year note was 2/32 higher to yield 2.424%, the seven-year note was 4/32 higher to yield 1.753%, and the five-year note was 2/32 higher to yield 1.122%. Bond prices move inversely to yields.
Bonds fell earlier Wednesday on a strong rally in stocks and a relatively lukewarm sale of $21 billion in 10-year notes.
Buyers returned in the afternoon session as the size of the Fed's purchase plan exceeded the forecast of $26 billion to $29 billion by many market participants. It was higher than the previous two rounds of buying.
"It may be a signal from the Fed that they will be aggressive with government debt purchases," said Michael Franzese, head of Treasury trading at Wunderlich Securities in New York. "That gave the bond market a boost."
The Fed's buying was part of the small-scale Treasury purchase program launched in August in which the central bank reinvests proceeds from its maturing mortgage-backed securities holdings.
Treasury yields had dropped over the past few weeks as speculation grew that the Fed will step up bond buying to push down long-term borrowing costs for U.S. households and companies.
The Fed signaled it will provide additional support to the economy before long, according to the minutes of the Fed's monetary policy meeting released Tuesday. But policy makers are still split on the timing and the size of Treasury bond purchases.
Investors are bracing for the $13 billion 30-year bond auction on Thursday, the last leg of this week's sale of $66 billion in new government debt supply.
The 30-year bond was the only loser, with its prices down 3/32 to yield 3.824%. The bond has underperformed in recent days on speculation that the Fed may concentrate its debt buying in shorter-dated Treasurys.
Many investors also dumped the 30-year bond on worries that the Fed's monetary stimulus may generate inflation in the longer term. The longer the maturity, the more the bond's value falls when consumer prices rise.
The yield premium to hold the 30-year bond rather than the benchmark 10-year note rose to a record high of 140 basis points. The premium has surged from 118 basis points at the end of September.
"The long end of the Treasury market has been struggling as market participants are worried that the Fed wants to ignite inflation," said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York. "That made the 30-year sale very tricky."
Two favorite inflation-hedge assets have enticed strong demand in recent weeks. Gold hit a record high of $1,375.70 an ounce Wednesday while Treasury Inflation-Protected Securities extended their rally.
A gauge of inflation expectation in the TIPS market has risen. The 10-year breakeven rate, the yield spread between 10-year TIPS and 10-year conventional Treasurys, rose to 204 basis points Wednesday, the first time the gap broke the 200-basis-point level since June. It suggested that investors bet on an average annualized inflation rate of 2.4% within a decade.
The rate has jumped from the recent trough of 147 basis points in August as speculation of more stimulus from the Fed gained traction.
Demand for the 10-year notes auction, an additional sale of the supply in August, was still healthy. The securities were sold at 2.475%, the second lowest auctioned yield for the maturity. The U.S. government continues to finance its budget shortfall at historically low interest rates.
But the auctioned yield was above the 2.466% level traded right before the sale. The higher yield means bidding prices were weaker than market participants had expected.
The 10-year auction were 2.99 times oversubscribed, down from 3.17 for the previous eight auctions.
"The results are not overly awe-inspiring," said John Briggs, U.S. interest rate strategist at RBS Securities Inc. in Stamford, Conn.
The two-year spread, which measures the differential between the two-year swap rate and two-year Treasury yield and is a main gauge of credit risks, was 1.25 basis points tighter at 15.75 basis points. The 10-year swap spread was 0.75 basis point tighter at 7.75 basis points.