Cantor Fitzgerald

Justin Lederer Comments: Rally By Treasurys Is One For Books

January 27, 2012, Wall Street Journal

Medium-term Treasurys made a few entries in the record books as the market continued to rally off the Federal Reserve's bond-friendly policy.

Five-year Treasurys added to last session's gains, dragging yields to an all-time low, sinking as far as 0.752% on Thursday. But it was the seven-year notes that led the charge, allowing the U.S. government to pay a meager 1.359% yield at Thursday's auction, which is the lowest rate on record for this maturity.

Medium-term Treasurys have been the stars of the bond market following the Fed announcement Wednesday to keep interest rates near zero through at least late 2014. The move has bolstered stocks, commodities and bonds, and the policy surprised market participants because the period is longer than most investors had expected.

Shorter-dated Treasurys are more sensitive to interest rates, with two-year yields falling to 0.203% at one point Thursday, the lowest level since last September. But with these yields pinned to the floor, the Fed's latest announcement is cranking yields on longer-dated notes lower as well. The prolonged era of low rates encourages buyers because it reduces interest-rate risk for investors holding bonds with longer maturities.

"The market is in good hands," said Justin Lederer, senior trader of interest rates at Cantor Fitzgerald LP. "As the yield curve compresses, people are going to extend out on the curve to get yield."

The curve is the gap between the yields of different Treasury maturities. Analysts expect the curve to flatten between two- and seven-year notes, meaning relatively longer-dated yields will fall faster that shorter-dated ones. Indeed, the yield gap between two- and seven-year notes shrank by more than 0.13 percentage point since the Fed announcement, to 1.106%.

Strong buying and sinking yields, however, didn't mean everything was rosy. Many market observers were caught off guard with the weak seven-year note sale; analysts had expected high demand for the auction.

The record-low yield being offered by the Treasury may have turned off some buyers, forcing the government to pay a slightly higher yield, according to bond-market participants. Overall demand as measured by the bid-to-cover ratio came in at 2.73, below the 2.87 average over the last four sales of this maturity.

Direct buyers, composed largely of domestic banks and investment managers, purchased 11.6% of the $29 billion offering. That is below the 14.3% average and the weakest since August of last year. Foreign interest also was on the light side, as these buyers scooped up the smallest proportion since March 2009. But this turned out to be only a minor bump, as investors returned to the market after the brief bout of selling caused by the tepid auction.

Late Thursday in New York, the 10-year note rose 22/32 point, or $6.875 per $1,000 valuation, to 100 19/32, to yield 1.933%, compared with 2.009% late Wednesday, as bond yields move inversely to prices. Two-year notes gained 1/32 point, to yield 0.215%; seven-year notes gained 17/32 point, to yield 1.321%.

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