Treasuries drop on bailout speculation before 5-year note sale

July 25 (Bloomberg) -- Treasuries fell, snapping a three- day advance, as speculation that European policy makers will boost the firepower of their bailout fund damped demand before the U.S. sells $35 billion in five-year notes.

Ten-year note yields climbed from a record low after European Central Bank council member Ewald Nowotny said there are arguments in favor of granting the European Stability Mechanism a banking license, giving it access to ECB lending. Yields on five-, seven-, and 30-year Treasuries also dropped to all-time lows for a third straight day in earlier trading.

“We’ll be talking about Europe for years,” said Ray Remy, head of fixed-income in New York at Daiwa Capital Markets America Inc., one of 21 primary dealers that trade directly with the Federal Reserve. “You have an auction in five-year notes today and seven-year notes tomorrow -- sometimes the market has to get cheaper to get through the supply.”

The benchmark 10-year yield rose three basis points, or 0.03 percentage point, to 1.42 percent at 8:52 a.m. in New York, according to Bloomberg Bond Trader prices. The 1.75 percent note due in May 2022 fell 22/32, or $6.88 per $1,000 face amount, to 102 25/32. The yield earlier dropped to 1.3790 percent.

Treasuries have returned 3.2 percent this year, boosted by a 1.5 percent gain this month as of yesterday, according to Bank of America Merrill Lynch indexes. The securities trail a 4.2 percent gain this year and a 2.1 percent gain this month from German bonds, according to the indexes.

Debt Sale

The five-year notes being sold today yielded 0.58 percent in pre-auction trading, compared with 0.752 percent at the previous sale on June 27. Investors bid for 2.61 times the amount offered last month, the least in a year.

Primary dealers, which underwrite the U.S. debt, bought 54.1 percent of the securities, the most since February 2011. Indirect bidders, the category of investors that includes foreign central banks, purchased 35.1 percent, the least since the same month.

The U.S. sold $35 billion of two-year notes yesterday at an all-time low yield of 0.220 percent, drawing almost record demand. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was the second-highest ever at 4.0, compared with an average of 3.72 for the past 10 sales. The record was 4.07 percent in November 2011.

The Treasury concludes this week’s auctions with a $29 billion sale of seven-year debt tomorrow.

The Fed plans to buy as much as $5.5 billion of Treasuries due from August 2020 to May 2022 today, according to the Fed bank of New York’s website. The purchases are part of the central bank’s plan to put downward pressure on borrowing costs by swapping short-term Treasuries in its holdings for longer maturities.

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