Bond Brief: Treasuries Hold Steady

The bond market overcomes early weakness despite concern about supply ahead of the Treasury's refunding auction.
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Updated from 11:23 a.m. EST

Treasuries erased losses Monday to end the day little changed. Earlier in the session, upcoming debt auctions and an upward revision in the leading indicators report weighed on prices.

The billions of government debt on tap over the next month is an issue that could dog the Treasury market for weeks, as could uncertainty surrounding when the

Federal Reserve

will stop raising interest rates.

The Treasury announced Monday it will auction $22 billion worth of two-year notes on Wednesday, a bit more than Wall Street analysts had forecast. It will also offer $12 billion in four-week bills on Tuesday. That's part of the Treasury's quarterly refunding auction, which analysts estimate could top $110 billion. Corporate issuance is also expected to remain heavy this week.

"The market put in a surprising bid on Monday, albeit on tame volume and a lack of key data," says David Ader, bond strategist with RBS Greenwich Capital. "If we need a fundamental rationale

for the rebound we can discuss expectations for a soft

fourth-quarter GDP read this Friday."

The benchmark 10-year note closed down 2/32 to yield 4.36%, up from 4.35% late Friday. Bond prices and yields move in opposite directions. Earlier in the session, the yield on the 10-year rose as high as 4.39%.

The two-year note was little changed to yield 4.35%, while the three-month bill was up 1/32 to also yield 4.35%.

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.

The spreads between the 10-year yield and the yields on shorter-maturity debt have been nearly flat for months, and briefly inverted by a few basis points during the final week of 2005 and last week.

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 30-year bond ended the day down 6/32 of a point to yield 4.53%, little changed on the session. The bond fell as low as 22/32 in morning trading. The five-year lost 1/32 to yield 4.29%.

In morning trading, bonds sold off sharply on concerns about excess supply in a range-bound market that had few economic indicators to guide it.

"The refundings always weigh on prices," says Drew Matus, senior U.S. economist with a specialty in fixed income at Lehman Brothers. "This time around people are worried about how big the

return of the 30-year bond is going to be."

Alan De Rose, a bond trader with CIBC World Markets, estimates that the government could sell well more than $110 billion of Treasuries over the course of seven auctions, and Matus says that the government could attempt to raise even more than that to fund hurricane-related repairs in the Gulf Coast region.

The sales begin tomorrow with $10 billion worth of 20-year inflation-linked bonds, or TIPS.

"Typically the 20-year TIPS tend to back yields up a little bit because there's not as much of a natural demand for them as there is for generic Treasuries," according to De Rose.

He says that traders will observe the sales to see just how much the additional supply weighs on prices and by how much the yield curve steepens.

The Treasury also announced it will auction $22 billion worth of two-year notes on Wednesday, a bit more than Wall Street analysts had forecast. It will also offer $12 billion in four-week bills on Tuesday.

Corporate issuance is expected to remain heavy this week. Last week's shortened trading week saw $8.8 billion in new corporate issues, after seeing a record $37.9 billion issuance the week before.

BAA Plc

, the world's largest airport operator, will sell mixed currency bonds in two parts this week.

NRG Energy

(NRG) - Get Report

will sell $3.6 billion in high yield bonds this week and Austria's third largest bank,

Raiffeisen Bank

, will sell $613 million debt.

In agency action,

Freddie Mac

(FRE)

sold $2 billion in one-month bills and $3 billion in three-month bills.

Fannie Mae

(FNM)

will sell $2 billion in three-month and $1.5 billion in six-month bills on Wednesday.

The index of leading indicators report, a compendium of previously announced economic data including new orders, jobless claims, money supply, building permits and stock prices, pushed prices lower in the morning.

The index showed a 0.1% rise vs. Wall Street estimates for a 0.2% gain. However, the November figure was upwardly revised to show a 0.9% gain vs. 0.5% previously.

"People are scraping the bottom of the barrel looking for indicators about where the economy is and for signs that the

Fed

will or will not" tighten, says Matus.

Matus says the market sees the large upward revision in November's LEI as a sign that the Fed could hike rates more than anticipated, particularly in light of recent comments by St. Louis Fed president William Poole, who suggested the central bank will raise the overnight lending rate two more times.

The heaviest hitting economic reports are due out later in the week, including the fourth-quarter GDP report and readings on existing and new-home sales for the month of December.

Few Fed officials are slated to comment ahead of the Federal Open Market Committee meeting on Jan. 31.