Bloomberg News

Treasuries Advance as Fiscal Cliff Pushes Demand to 8-Year High

November 28, 2012

Treasuries advanced after the U.S. sale of five-year notes drew the highest demand in eight years from direct bidders amid concern Congress faces headwinds in resolving the fiscal cliff of tax increases and spending cuts.

Direct bidders, non-primary dealer investors that place their orders with the Treasury, purchased 15.9 percent of the notes, the most since September 2004. The Federal Reserve said seven of 12 districts reported concern about the outlook for 2013, in part, due to the uncertainty regarding a possible political stalemate on the deficit that could lead to automatic spending cuts and tax increases at the start of the new year.

“The fiscal cliff is helping to develop that safe-haven bid for Treasuries,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors. “There’s still the uncertainty around that and that’s underlying.”

The yield on the benchmark 10-year note fell one basis points, or 0.01 percentage point, to 1.63 percent at 4:59 p.m. in New York after touching the least since Nov. 20, according to Bloomberg Bond Trader prices. The 1.625 percent note due in November 2022 gained 2/32, or $0.63 per $1,000 face amount, to 99 31/32.

The yield on the current five-year note fell one basis point to 0.63 percent. Thirty-year bond yields rose one basis point to 2.80 percent after falling as much as four basis points.

Ten-year yields dropped earlier today as Erskine Bowles, co-chairman of President Barack Obama’s 2010 fiscal commission, estimated there is a one-third probability of a budget deal by the end of this year.

Investor Demand

The five-year notes sold today drew a yield of 0.641 percent, compared with a forecast of 0.649 percent in a Bloomberg News survey of seven of the Fed’s 21 primary dealers, which are required to bid at U.S. debt auctions.

Indirect bidders, an investor class that includes foreign central banks, purchased 45.4 percent of the notes, compared with an average of 41.9 percent for the past 10 sales.

Direct bidders have purchased an average of 10.8 percent at the past 10 auctions.

Five-year notes have returned 2.3 percent this year compared with the 2.5 percent gain by Treasuries overall, according to Bank of America Merrill Lynch indexes. The five- year securities rose 9.2 percent in 2011, while Treasuries overall advanced 9.8 percent.

Today’s offering was the second of three this week totaling $99 billion. The government will sell $29 billion in seven-year securities tomorrow. Yesterday’s auction of $35 billion in two- year notes yielded 0.295 percent produced 4.07 times the amount of bids than debt sold, matching a record for U.S. coupon securities.

Yield Curve

The difference between the yields on two and 10-year notes, the so-called yield curve, narrowed to 1.34 percentage points, the lowest in almost two weeks.

A yield curve plots the rates of bonds of the same quality, but different maturities. It steepens when yields on shorter- maturity notes fall, those on longer-dated bonds rise, or both happen simultaneously. The gap typically narrows when investors anticipate a slower recovery as they demand less compensation in anticipation of limited inflation.

President Barack Obama said at the White House that “My hope is to get this done before Christmas.” U.S. House Speaker John Boehner earlier said he was “optimistic” budget talks with Obama would continue.

Price Swings

Volatility in Treasuries dropped yesterday to the least in five years. Bank of America Merrill Lynch’s MOVE index, which measures price swings based on options, declined to 51.7, the lowest level since May 2007. It hit a 2012 high of 95.4 basis points. Volatility climbed to 264.6 basis points in October 2008 as the financial crisis intensified.

“The Fed buying in the market has been a lot of the reason why volatility has decreased,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “They have obviously pushed rates to levels that obviously are artificial. There’s no new news out of Europe and there has been a couple of headlines on the fiscal cliff. It all adds up to taking people out of the market and they are sitting on the sidelines for now.”

The Fed bought $1.85 billion of Treasuries maturing from February 2036 to November 2042 today, according to the Fed Bank of New York’s website. It also purchased $4.6 billion of securities due from November 2018 to November 2020, the website shows.

Quantitative Easing

The next release of the tentative outright Treasury operation schedule will be at 2 p.m. on Nov. 30. The Fed is also selling shorter-term Treasuries from its holdings and buying those due in six to 30 years, under a program scheduled to end next month.

The central bank is seeking to put downward pressure on yields, after buying $2.3 trillion of Treasuries and mortgage- related bonds since 2008 in two rounds of quantitative easing, or QE. It said Oct. 24 it would extend its stimulus by purchasing $40 billion of home-loan securities a month until the labor market improves “substantially.”

The U.S. economy expanded at a “measured pace” in recent weeks as gains in consumer demand and housing were tempered by a slowdown in manufacturing and the impact of hurricane Sandy, the Fed said today in its Beige Book survey, which is based on reports from the Fed’s 12 district banks.

The Fed said seven of 12 districts reported “either slowing or outright contraction in manufacturing” as some contacts “expressed concern about the outlook for 2013, in part, due to the uncertainty regarding the outcome of the fiscal cliff.”

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; 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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