Is strong 2-year note auction good news or bad?

The U.S. sold $29 billion of two- year notes at close to the highest yield in three years, less than a week after Federal Reserve Chair Janet Yellen said interest-rate increases may come sooner than forecast.

The securities drew a yield of 0.530 percent, compared with a forecast of 0.533 percent in a Bloomberg News survey of five primary dealers. The notes attracted a high yield of 0.544 percent in July, the most since May 2011. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of debt offered, was 3.48 the strongest since May, versus an average of 3.4 at the past 10 sales.

“The two-year note has had a relentless bid despite the pressure and potential hawkishness from the Fed -- and maybe because of it,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 22 primary dealers that bid at Treasury auctions. “It’s impressive that demand is still there despite the quiet markets, and it suggests that any significant selloff will be meet by buyers.”

The yield on the current two-year note maturing July 2016 fell about one basis point, or 0.01 percentage point, to 0.49 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. The price of the 0.5 percent note was 100.

Yields on benchmark 10-year notes rose one basis point to 2.40 percent. Thirty-year bond yields increased three basis points to 3.16 percent.

Butterfly Spread

“With the recent cheapening in the front-end, investors are selling the long-end and buying shorter-term securities with the expectation that the auctions will go well,” said Jason Rogan, managing director of U.S. government trading at Guggenheim Securities LLC, a New York-based brokerage for institutional investors. “With rates so low in Europe and the FOMC in effect offering higher yields, the trade is drawing people in.”

The butterfly spread formed by two-, five- and 30-year Treasury yields suggests the middle security is poised to outperform the other two. The index reached negative 34 basis points, almost the the highest since August 2009. It has averaged negative 83 basis points over the past year. A higher reading signals investors are more bearish on the middle of the three securities, making it relatively cheap versus the others.

Traders saw about a 54 percent chance the Fed will boost its benchmark rate from the current range of zero to 0.25 percent by July 2015, according to futures data compiled by Bloomberg. The odds were 48 percent a week earlier.

International Demand

If U.S. labor markets keep improving then policy makers may raise rates sooner than traders estimate, Yellen said at the Fed Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming, on Aug. 22.

U.S. two-year notes yield the most versus similar-maturity German debt since 2007 with European Central Bank policy makers considering bond purchases to spur economic expansion.

Investors demanded 52 basis points more to own the U.S. notes, after pushing the yield on the German debt to negative 0.046 percent yesterday.

Indirect bidders, an investor class that includes foreign central banks, purchased 39.8 percent of the notes, the most since the March sale, and compared with an average of 27 percent for the past 10 sales.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 12.1 percent of the notes at the sale, compared with an average of 23 percent for the past 10 auctions.

The U.S. will sell $48 billion in fixed- and floating-rate debt tomorrow. The Treasury will auction $29 billion of seven- year securities Aug. 28.

 

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