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Bond Brief: Treasuries Lower After Rough Auction

Indirect bidders get only 28.5% at a $13 billion auction of five years.

Updated from 2:10 p.m. EST

Treasury prices ended lower Wednesday after a disappointing five-year note auction, as traders braced for a slew of economic reports Thursday including trade data, jobless claims, import and export prices and budget numbers.

"When you look back over the last 30 months, this auction drew the third-worst bid-to-cover ratio we've seen for the five-year and the third-worst indirect participation," says John Herrmann, director of economic commentary for Cantor Viewpoint, a unit of bond brokerage Cantor Fitzgerald. (The indirect bidder category of bond buyers at auction is viewed as a proxy for foreign central banks.)

"That's very peculiar because the month of January is typically associated with strong institutional interest and strong overseas central bank interest," he says.

The benchmark 10-year note ended the session down 6/32 in price, pushing up its yield to 4.45%, from 4.43% late Tuesday. The 30-year bond dropped 10/32 to yield 4.63%, up from 4.61% in the previous session. Bond prices and yields move in opposite directions.

The two-year note edged down 2/32 to yield 4.42%, and the five-year lost 4/32 to yield 4.39%. The yield on the five-year rose by 2 basis points after the debt auction.

Just before the results of the $13 billion auction were released, the 10-year yield was steady at 4.43% and the two-year yield was at 4.39%.

The five-year notes drew a yield of 4.37%, and for every $1 sold, there were $2.10 worth of bids, making the bid-to-cover ratio 2.1. The bid-to-cover ratio has averaged 2.53 over the past 10 debt sales.

Indirect bidders, which include foreign central banks and domestic pension funds, bought 28.5% of the securities sold, compared with 44% last month.

Herrmann says this means some buyers, particularly foreign ones, are probably staying out of the market until they see how

Federal Reserve

policymakers handle interest rates in January, and whether it looks like they'll raise in March.

Interest-rate futures show that traders are pricing in a 96% chance that the Fed will raise the overnight lending rate to 4.5% at its Jan. 31 meeting. The odds for an additional quarter-point hike to 4.75% on March 28 are now at 62%, up from 46% last week.

They'll also closely monitor the January payroll report due out Feb. 3 and reassess their positions at the quarterly refunding scheduled for the beginning of February, he says.

This market is really watching for indirect bidder participation, says Herrmann.

"With indirect bidder participation low, we'll see lower yields."

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This is because relatively slow growth in Europe and Asia has made Treasuries unusually attractive for overseas investors, he said. Plus, foreign central banks have been recycling the dollars that we spend on their cheaper goods back into the U.S. economy.

The Treasury reports that foreign banks now own more than half of all U.S. government debt, and more than even the Federal Reserve.

Since May 2003, the proportion of five-year note sales won by indirect bidders has ranged from 14% to 65.8%, and averaged 38.7%, according to the Treasury.

Foreign participation has helped keep long-bond prices high and yields low. Since mortgage rates are set in step with the rise and fall of the 10-year yield, this has also helped to keep the 30-year mortgage rate low and housing activity robust.

Herrmann says that supply could continue to weigh on prices, as the five-year auction kicked off a series of seven debt sales that will occur over the next month.

The Treasury will sell $9 billion of 10-year inflation-protected notes, or TIPS, Thursday. In the next four weeks, the government will sell two-, three- and 10-year notes, as well as an auction of the 30-year bond for the first time in more than four years.

estimates that the total debt on offer will amount to $100 billion.

Moreover, a high volume of corporate debt has been recently auctioned, further depressing Treasury prices as fixed-income buyers diversify away from the government bond market.

Freddie Mac sold $2 billion in three-month and $1 billion in six-month bills, and said that it will sell another $5 billion in two-year notes and $4 billion in 10-year notes Thursday.

Mohawk Industries

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said it will sell $1.4 billion in debt, and



said it will sell about $2.5 billion in 10-year notes.

The market shrugged off comments on monetary policy delivered by New York Federal Reserve Bank President Timothy Geithner, a voting member of the

Federal Open Market Committee

. Federal Reserve Board governor Mark Olson is slated to discuss Fed responsibilities at 7:30 p.m. EST.

Separately, crude oil inventories declined more than expected, but distillates, which include heating oil, rose by more than forecast.

The bond market has been closely tracking energy prices in the hopes that higher fuel costs would not raise core inflation readings.

A higher inflation outlook could prompt the central bank to take rates higher.