Bonds Slip as Three-Day Auction Begins

The market is absorbing new supply, and yields are continuing to edge higher.
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The bond market loosened its belt by a notch today to eat up $15 billion of five-year supply, the first leg of the three-day quarterly

Treasury

refunding. Bond prices hovered just above even for most of the day, but like a gourmand collapsing into a chair, relaxed in the waning hours in the knowledge that this was only the appetizer -- pasta and veal are still on the way.

The Treasury will sell $12 billion in 10-year notes tomorrow and $10 billion in 30-year bonds Thursday, so both those issues were marked down following today's five-year auction. Lately the 30-year Treasury bond was down 4/32 to trade at 86 19/32. The yield bumped up by 1 basis point to 6.25%.

By the accounts of three sources, the five-year auction was reasonably successful. The bid-to-cover ratio, which measures the total level of interest vs. what was sold, was 1.85 to 1, which compares favorably with 1.82 average for the last four five-year auctions. Total noncompetitive bids -- basically, that's retail investors who aren't trying to outplay other primary dealers for the best price -- were $557 million, slightly better than expected and also better than the $410.5 million average for the last four auctions. This was expected, especially since the five-year yield reached its highest level in 21 months, at 6.03%. The new notes sold at a yield of 6.014%.

Kevin Flanagan, money-market economist at

Morgan Stanley Dean Witter

, characterized today's auction as the best positioned of the three. The five-year is yielding about 100 basis points over the current fed funds target of 5%. This already "allows for a tightening" at the next

Federal Open Market Committee

meeting Aug. 24, he said. Meanwhile, the 10-year note is only yielding additional 13 basis points for a riskier security, and the 30-year just 22 basis points. "There really isn't an incentive by the investor, but the five-year note is situated well on the curve."

There are, of course, risks for the investor in upcoming weeks. The entire curve could continue to lose ground as more strong or inflationary economic data are released. This Friday features the July

Producer Price Index

, followed with next week's

Consumer Price Index

, both key inflation indicators. Of course, the

Fed

looms after that, and while most believe the market's prepared for the committee to raise the fed funds target to 5.25%, that doesn't mean the market's going to like it.

"It's hard to get long in front of two auctions," said Roseanne Briggen, market strategist at

MCM Moneywatch

. "We've got a booming economy, robust employment, and it looks like the Fed's going to tighten."

Another factor depressing the bond market is the rise in the

Bridge/Commodity Research Bureau

index, which rose to 198.48 today, just off the year's 198.96 high. The bond market worries about recovery in commodities because higher commodity prices could work its way into the economy in higher prices for producers and later, for consumers.

Electronic Trading Resumes on CBOT

The

Chicago Board of Trade's

computerized trading system, which handles overnight trading in interest rate and agricultural futures and options, finally resumed trading today after the futures pits closed at 3:15 p.m. EDT, after a three-day shutdown.

The system, also known as Project A, originally collapsed due to an outage at an

MCI WorldCom

(WCOM)

switching center, causing overnight CBOT trading to be suspended at 9:21 p.m. Thursday, and throughout the last two overnight sessions (Sunday to Monday and Monday to Tuesday).

The outage wouldn't affect the daily session from 8:20 a.m. to 3 p.m., known as "open outcry," when the bulk of trading takes place. However, it meant traders conducting business overnight -- primarily the European and Asian markets -- were frustrated in their attempts to make timely trades. "It's like online brokers going down," said one futures trader in New York. "You can't get out of your position, and you can't manage your risk."

Average daily volume for Project A during July was 45,575 contracts, compared with the total exchange's average daily volume of 1,020,424 contracts in July, a CBOT spokeswoman said.