Brian Edmonds Comments: Treasurys Slip As Investors Prepare For Auctions

July 12, 2010, The Wall Street Journal

The Treasury sold three-year notes for the lowest yield on record Monday, yet prices still slipped as investors set up for the government's remaining 10- and 30-year auctions this week.

The government's sale of $35 billion in new three-year notes drew over three times that amount in bids but, despite the record low yield, the auction disappointed the market which had expected even lower yields. The new notes yielded 1.055%, the lowest yield on record for three-year sales, traders said. Ahead of the sale, the market had seen the yield at 1.046%.

"The auction was not quite as well as received as you would have thought, said Brian Edmonds, head of interest rates at Cantor Fitzgerald in New York, with some investors staying away given ultra low Treasury yields. "It doesn't seem super-attractive to me to own three-years at these levels," said Edmonds.

Following the three-year sale, market participants reassessed their expectations for the 10- and 30-year sales taking place Tuesday and Wednesday which come amid a slew of government debt sales in the euro zone also. The remaining two offerings are add-on sales to existing series of these securities: $21 billion in 10-year notes and $13 billion in 30-year bonds.

Edmonds said a 10-year yield of 3.10% to 3.15% and a 30-year yield of 4.10% to 4.15% would attract buyers, but given ongoing economic uncertainties, even current yields should draw some demand.

Market participants expect these auctions to go well given investors recent preference for higher-yielding, long-maturity Treasurys. The 10-year yield has also risen by some 15 basis points from the low it hit in early July, adding to its attraction. Bond yields rise when prices fall.

Treasurys have remained in high favor since the spring as worries have risen about the strength of the global economic recovery and the potential of the euro zone's debt crisis to spread.

In afternoon trading, most Treasury prices were lower. The price of the three-year note was off 2/32 to yield 1.032%, the two-year note was down 1/32 to yield 0.649%. The 10-year note was off 1/32 to yield 3.061%. The 30-year Treasury was off by 8/32 to yield 4.054%. Bond prices move inversely to bond yields.

The three-year auction, which was $1 billion less than the last three-year sale, drew bids of 3.20 times the amount on offer, compared with the 3.23 bid-to-cover at the last three-year auction and just above the 3.18 average bid-to-cover at the last four three-year auctions.

The last time the yield on the new three-year notes was higher than the yield before the sale was back in February.

Indirect bidders, domestic and foreign institutions, including foreign central banks, took 41% of the notes, less than the 46.7% they took in June and less than the 50.4% four-auction average. Direct bidders, large money managers, hedge funds and foreign investors with their own accounts at the Treasury, took 14% after taking 16.3% at the June sale and the average 13.5% they took at the last four three-year sales.

Market participants said they thought the smaller auction size would help--the $35 billion offering was down from a peak of $40 billion in April. The government has been trimming its auction sizes this year, citing better tax receipts.

The auction was "decent, but not spectacular on the face of it," said William O'Donnell, head of U.S. government bond strategy at RBS Securities Inc. in Stamford, Conn.

Weaker Treasury prices came as stocks eked out small gains Monday after last week's rally. Investors are bracing for the start of the second quarter earnings season.

Agency MBS Flat

Agency mortgage-backed securities were flat compared to Friday. "Volume was pretty light," said Kevin Cavin at Sterne Agee in Chicago. "Some sections of the market are showing response to refi activity but lending standards are very tight and borrowers are having to go through the wringer to qualify for new loans. That has slowed refi activity relative to rates, he said. Risk premiums on agency mortgages were quoted at 129 basis points, the same as late Friday.

Swap spreads were wider. The two-year spread widened to 31.50 basis points from 30.25 basis points, and the 10-year spread widened to 5.75 basis points from Friday's 5.50 basis points. Swap rates were at 0.960% and 3.119%, respectively.