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Bond Brief: The Weight of Supply

Treasury prices end near session lows after a lackluster TIPs auctions and ahead of the forthcoming refunding.

Updated from 1:57 p.m. EST

Treasuries ended the day near session lows Tuesday after an afternoon debt auction came in slightly weaker than expected.

With no economic reports to guide the market and only one

Federal Reserve

speaker on tap, supply weighed on prices after the $10 billion in 20-year inflation-protected securities (TIPs) drew a yield of 2.04%, vs. the 2.01% forecast by Bloomberg.

Indirect bidders, which includes pension funds and overseas investors, bought 56.1% of the debt on offer, just below the record 60.3% at the Jan. 12 TIPs sale.

But the bid-to-cover ratio was 1.48, meaning that for every $1 sold, there was $1.48 worth of bids, well below the average $2.02 for the last 13 sales.

While the results kept bond prices in the red, Alan De Rose, a bond trader with CIBC World Markets, says that this is typical since there is less natural demand for TIPs as opposed to generic Treasuries.

The benchmark 10-year closed down 8/32 to yield 4.39%, up from 4.36% late Monday. The 30-year bond sank 19/32 to yield 4.57%, up from 4.54% in the previous session. Bond prices and yields move in opposite directions.

The two-year note lost one tick to yield 4.37%, widening the spread between its yield and that on the 10-year note, while the five-year dropped 3/32 to yield 5.31%. Most recently, the three-month bill was yielding 4.40%, a basis point higher than the 10-year yield.

Yields on longer-dated Treasuries are usually higher than on shorter-dated ones to compensate investors for the additional risk of lending money for a longer period of time. When yields on the short end rise higher, "inverting" the curve, it could mean that investors see more risk in the near term, a perception that has historically preceded an economic slowdown or recession.

An inversion in the spread between 10-year and three-month yields is the spread that the Federal Reserve is most concerned with, according to Miller Tabak. The brokerage firm says that once the inversion between these yields hits the midteens, in terms of basis points, odds of a recession within four quarters jumps to 30%.

The market see more action Wednesday, when existing home sales for December are reported. Some economists worry that a housing slowdown could give way to a soft economy, since U.S. consumers have used their rapidly rising home equity to boost purchasing power and the strong market has created jobs.

The government's weekly crude inventory report will also be released Wednesday morning.

In debt auction news, the Treasury will auction $22 billion worth of two-year notes on Wednesday, a bit more than Wall Street analysts had forecast and $2 billion more than in the previous auction, which was the biggest two-year bond auction since May 2005.

It will also sell $12 billion in four-week bills on Tuesday.

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Next week will also kick off a $46 billion Treasury refunding, according to David Ader, bond strategist with RBS Greenwich Capital, the securities business of Greenwich Capital. The firm is one of the 22 primary U.S. government securities dealers required to participate in Treasury auctions.

The large amount of supply in the pipeline has weighed on prices, as the market reshuffles to make room for the new securities.

In corporate issues,

Southern California Edison

said it will sell $500 million in two parts later in the session, and

Freddie Mac


sold $1.5 billion in six-month bills.

The market has been trapped in a "grinding sideways range," says David Ader, bond strategist with RBS Greenwich Capital, the securities business of Greenwich Capital. "It's been frustrating for bulls and bears."

The past few sessions have ended essentially flat, with some intraday firmness but no real breakouts.

But the world will look a lot different in next week, says Ader, adding that Treasuries could break out of their recent tight ranges after the core PCE deflator is released, one of the Fed's favorite inflation indicators, and the presumed quarter-point rate hike hits on Jan. 31.

"The FOMC is presumably moving into neutral, and it's been priced into the market," he says. "Now we get a sense of whether people have bought the rumor, and we'll see whether they decide to sell the fact."

RBS chief economist Stephen Stanley forecasts that fourth-quarter GDP, due out Friday, will show a weak 2.8% gain, down from 4.1% in the previous quarter, which could be bullish for the bond market.

Fed Governor Mark Olson gave a public lecture Monday night on the Susquehanna University campus, noting that central bankers are "watching very carefully the potential impact" of price pressures within the industrial sector and labor reports. He is also slated to speak with students today.

While he didn't speak specifically about the short-term outlook for Treasuries, Lacy Hunt, executive vice president of Hoisington Investment Management and an economist who worked at the Dallas Fed, says the prospects for the market are good because inflation and inflationary expectations are contained.

"These are the factors that ultimately determine the day," says Hunt. "There are a lot of indications that the Fed has the oil price increases of the last couple of years sealed off and contained to the energy sector. Despite all of the background noise, the bond market will stay focused on the fact that the Fed is achieving a deceleration in the basic cost of living."