Bloomberg News

U.S. Sells Seven-Year Notes at Record Low Yield Amid Fed Rally

January 26, 2012

Jan. 26 (Bloomberg) -- Treasuries rallied for a second day as the Federal Reserve’s pledge to keep borrowing rates low and consider additional asset purchases pushed the yield to a record low at today’s auction of $29 billion in seven-year notes.

The securities drew a yield of 1.359 percent, compared with the previous record low auction yield of 1.415 percent in November. Yields on five-year notes fell to all-time lows for a second consecutive day after Fed Chairman Ben S. Bernanke yesterday unexpectedly said that bond buying is “an option that’s certainly on the table.”

“Bernanke gave people a free pass to buy the belly of the curve,” Dan Mulholland, a Treasury trader in New York at RBC Capital Markets LLC, one of 21 primary dealers required to bid at government-debt auctions, said referring Treasuries maturing in the medium term. “Yesterday’s Fed announcement caught the market off guard.”

Current seven-year notes yields fell seven basis points, or 0.07 percentage point, to 1.32 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. The 1.375 percent note due December 2018 rose 14/32, or $4.38 per $1,000 face value, to 100 11/32.

The 10-year note yield fell six basis points to 1.93 percent. It fell seven basis points yesterday, the most since Jan. 11. Five-year yields fell four basis points to 0.77 percent after earlier touching a record low of 0.75.

Assets Soar

Investors who snapped up the Treasury’s $35 billion auction of five-year notes sold yesterday saw the assets soar as much as $238 million after the Fed pledged to keep interest rates low at least through late 2014.

The securities were auctioned at higher-than-average demand to yield 0.899 percent before touching a record 0.7601 percent in less than two hours.

“When you don’t have to worry about interest-rate policy, it makes it much easier,” said William Larkin, a fixed-income money manager who helps oversee $500 million at Cabot Money Management Inc. in Salem, Massachusetts. “There are lots of inflows going into fixed income, so the auctions get eaten up because of an appetite for safety.”

Today’s record low yield on the seven-year note was higher than the forecast of 1.346 percent in a Bloomberg News survey of eight of the Fed’s primary dealers.

“The auction tailed a little bit, but it’s not a disaster by any means,” said RBC’s Mulholland. A tail is a yield result higher than where the securities were trading before the auction.

Indirect Bidders

Indirect bidders, an investor class that includes foreign central banks, purchased 31.8 percent of the notes, the lowest since March 2009, compared with an average of 41.7 percent for the past 10 offerings. Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 11.6 percent, the same as the average at the past 10 auctions.

Treasury seven-year notes have dropped 0.3 percent this year after gaining 13.7 percent in 2011, according to Bank of America Merrill Lynch indexes. The overall Treasury market dropped 0.5 percent as of yesterday, after rising 9.8 percent last year.

Treasury market volume rose yesterday to the highest since Nov. 1 after policy makers said the Fed will remain accommodative. About $381 billion of Treasuries changed hands through ICAP Plc, the world’s largest interdealer broker, above the one-year average of $282 billion. Volume fell to about $320 billion today.

‘Monetary Accommodation’

Bernanke said yesterday the central bank is considering additional bond purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014. The Fed has already purchased $2.3 trillion of debt in two rounds of quantitative easing known as QE1 and QE2. U.S. policy makers are “prepared to provide further monetary accommodation,” Bernanke said after officials completed a two- day meeting yesterday.

“There certainly still could be a rally,” said Ian Lyngen, a government-bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “That said, we have priced in a fair amount of negative economic sentiments as well potential for the Fed to increase its balance sheet still further.”

The Fed bought $2.522 billion of Treasuries due from February 2036 to November 2041 today as part of its program to replace $400 billion of short-term debt in its portfolio with longer-term Treasuries in an effort to reduce borrowing costs further and counter rising risks of a recession.

Double Top

Treasury 30-year bond yields may fall below 2 percent as the Fed is more likely to extend the average maturity of its holdings than to buy more securities, according to Citigroup Global Markets.

A technical indicator known as a double top in a chart of long-bond yields indicates a decrease to as low as 1.8 percent with a drop “at least” to 2.1 percent, Tom Fitzpatrick, chief technical analyst at the Citigroup Inc. unit in New York, wrote today in a research note with colleagues.

Yields on 30-year bonds dropped six basis points to 3.09 percent today. Yields fell to a record low 2.51 percent in December 2008.

Shorter-term Treasuries tend to track what the central bank does with its target for overnight lending, while longer maturities are more influenced by the inflation outlook.

Fannie Yields

Yields on Fannie Mae’s current coupon 30-year fix-rate mortgage bond declined to 2.7 percent today, the lowest ever, as investors bet the Fed will continue easing. The yield declined to 78 basis points more than 10-year U.S. government debt, the tightest so-called spread since February.

The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, was 2.12 percentage points, under just the 10-year average of 2.13 percentage points.

The U.S. Senate voted today to permit a $1.2 trillion increase in the nation’s debt limit designed to be large enough to accommodate borrowing through the November election.

Fed policy makers set a long-term goal of 2 percent inflation yesterday, and forecast that price increases would fall short of that target this year and next.

Today’s sale was the final of three note auctions this week totaling $99 billion. The U.S. sold $35 billion of five-year debt yesterday at a yield of 0.899 percent, close to the record low yield of 0.88 percent reached at the Dec. 20 auction of the securities. It auctioned an equal amount of two-year notes the previous day at a yield of 0.25 percent, drawing stronger-than- average demand of 3.75 versus an average of 3.43 for the previous 10 sales.

Durable Goods

U.S. government-debt yields earlier fell as orders for U.S. durable goods rose more than forecast in December and claims for jobless benefits increased last week.

“The data has less importance in the market because the Fed has made an effort to say that, even if things improve, they still expect to remain accommodative for a considerable period of time,” said Thomas Simons, a government-debt economist in New York at Jefferies Group Inc., a primary dealer.

--Editors: Kenneth Pringle, Paul Cox

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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