Cantor Fitzgerald

Justin Lederer Comments: Bond Prices Fall Ahead of Auctions

June 13, 2012, CNBC

U.S. Treasurys prices fell on Tuesday as investors prepared for new sales of longer-dated Treasurys on Wednesday and Thursday, with losses accelerating after a three-year note auction saw relatively weak demand and priced at a concession.

The Treasury on Tuesday sold $32 billion in three-year notes at a high yield of 0.387 percent, with the notes pricing at 0.4 basis points higher than where they traded before the auction, the largest concession since February 2011.

Demand from indirect bidders, which includes foreign central banks, was also the lightest since the Treasury recommenced selling the debt in November 2008, at 27 percent.

"It was a weaker auction than I would have expected, though I don't expect the short end to go up much more from these levels," said Justin Lederer, interest rate strategist at Cantor Fitzgerald in New York.

The weakness of the three-year note auction may mean that further yield increases will be required for longer-dated debt sales this week. The Treasury will sell $21 billion in 10-year notes on Wednesday and $13 billion in 30-year bonds on Thursday.

"We are trading headline risk, so people are going to be very cautious to set up for the auctions," Lederer said. That said, "I do think there is a bid for Treasuries, especially as yields back up."

Dealers may take advantage of the Fed's 10-year note buyback on Wednesday to lighten up on holdings of the notes before the fresh supply, said Lederer.

The Federal Reserve will purchase as much as $5.5 billion in notes due 2020-2022 on Wednesday as part of its Operation Twist at 11am EST, two hours before the auction.

Traders on Tuesday were pricing in expectations that the new 10-year notes would price at around 1.67 percent which would be a record low auction yield.

The bond market sell-off was somewhat tempered by demand for safe-haven Treasurys as fears remained of debt issues in the euro zone spreading to larger countries including Italy.

Treasurys have benefited in recent weeks from investors swapping German bonds for Treasurys, on concern over Germany's exposure to weaker euro zone members and as Treasurys offer relatively higher yields.

"Some investors would rather have fixed Treasury exposure than exposure to bunds given Germany's prospective linkages to credit in Europe," said Russ Certo, head of rates at Gleacher in New York, noting there was a large Japanese account making this switch overnight.

The spread between 10-year Treasuries and 10-year German bunds yields has compressed to around 20 basis points, from 40 basis points two weeks ago.

Investors are now largely focused on Greek elections on Sunday, which may determine whether the country remains in the euro zone.

With near-record low Treasurys yields and many investors with short positions having already covered the trades, the risks have become more skewed that there could be an unexpected jump in yields on less negative news than expected, said Certo.

"There is a backdrop where the investment community may have been focusing on the malaise in markets and not on the potential for events to unfold that could be generally supportive for markets," he said.

Potential catalysts for this could be a more positive outcome in Europe than currently projected or that the Federal Reserve will not announce new quantitative easing when it meets next week, as many currently predict.

Benchmark 10-year Treasury notes were last 14/32 lower in price, yielding 1.64 percent, up from Monday's close.

Ten-year notes were last down 24/32 in price to yield 1.67 percent, up from 1.59 percent late on Monday. Thirty-year bonds rose 1-15/32 in price to yield 2.78 percent, up from 2.71 percent.