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Cool Reception for New 10-Year Notes Ends Rally

Also, comments by Treasury Secretary Larry Summers ease fears of a long bond shortage.

Today's 10-year Treasury note auction got a cool reception from investors, and that put a stop to a rally that had been underway in much of the Treasury market.

Then, in the session's final hour, comments by Treasury Secretary

Larry Summers

triggered an additional decline in the price of the 30-year bond. Summers indicated that issuance of 30-year bonds will continue indefinitely. Last week, an article in the

New York Times

suggested that might not be the case.

Treasury issues were mixed before the auction results were announced at about 1:30 p.m. EST, with the two-year note down and longer-maturity notes and the 30-year bond moderately higher. Demand for the 30-year issue has been running high because of government plans to reduce the supply of long-dated issues. Intermediate-maturity notes got moving around midday, when the stock market's decline accelerated. As for the two-year note, with the


poised to hike short-term interest rates at least once more, it seldom goes anywhere but down.

By the end of the day, the 10-year note (which is quickly displacing the 30-year bond as the Treasury benchmark) was down 6/32 at 95 16/32, lifting its yield 2.8 basis points to 6.646%. The two-year note finished up 1/32, trimming its yield 2 basis points to 6.648%.

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Today's auction was the second of three segments of the so-called quarterly refunding, in which the

Treasury Department

sells new intermediate-term notes and long-term bonds. Yesterday, it auctioned new five-year notes. Tomorrow, it will sell new 30-year bonds.

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The reception an auction gets often sets the tone in the Treasury market. The quality of the reception is measured by the bid-to-cover ratio it produces. The bid-to-cover ratio compares the volume of securities dealers bid for to the amount for sale. Higher is better.

Today's auction of $10 billion 10-year notes produced a bid-to-cover ratio of 1.45. The average for the previous five 10-year auctions produced an average bid-to-cover ratio of 1.95.

Demand for the notes was weak for two closely related reasons, said Matt Frymier, a Treasury note trader at

Banc of America Securities

in San Francisco. The wild swings in the Treasury market over the last two weeks left dealers gun shy, for one. "The recent volatility in the marketplace makes the auction process hazardous," Frymier explained. "You put a bid in and then you don't know the results for half an hour. That's a long half hour. Given the current environment of big spread moves, extreme volatility and choppiness, it scares professional players out of participating to the extent they would normally."

At the same time, those wild swings left the 10-year Treasury's yield below the two-year's yield. Why bother buying 10-year notes at a yield of 6.54% -- the yield at which the new issue was awarded today -- when you can get a two-year note at a yield of 6.648%?

Meanwhile, the 30-year bond, which was down about half a point after the 10-year auction results were announced (after trading up as much as 30/32 in the morning) ended down 30/32 at 97 20/32, lifting its yield 7.1 basis points to 6.303%.

Its decline accelerated after Summers told reporters in Washington: "I expect Treasury to continue to use the entirety of the yield curve as a way of holding down our borrowing costs." The remark was interpreted to mean that the Treasury will continue to issue 30-year bonds.

The Treasury has never said anything but that it would continue to issue 30-year bonds. Last Wednesday, when it announced the details of the quarterly refunding, it said only that it would curtail issuance in the 30-year sector in particular. Some future auctions of five- and 10-year notes would be "smaller," but some future auctions of 30-year bonds would be "significantly smaller," and there would be one fewer 30-year auction a year than before.

But the next day's

New York Times

characterized the announcement as "a move that could eventually eliminate the 30-year bond altogether." The 30-year bond, which had gained 1 27/32 on Wednesday, gained another 2 on Thursday, dropping its yield to the lowest level since mid-November.

Terming the article "very irresponsible,"

Paribas Capital Markets

senior bond strategist Richard Gilhooly said it had helped drive the bond's price significantly higher. Summers' comments refuted the


conclusion, "and that's why the long bond just collapsed," he said.

Regardless of the precise rationale for the late-day selloff, it underscored the fact that the 30-year issue is subject to forces that make it unreliable as a touchstone. "Once again we see that the 30-year trades in a world of its own,"

Banc One Capital Markets

senior financial economist Anthony Karydakis said. "This kind of price action explains why it has been deprived of its status as a benchmark for the Treasury market."

At the

Chicago Board of Trade

, the March

Treasury futures contract ended down 30/32 at 93 19/32.

Economic Indicators

There were no major economic releases today. The highlight of the next few days is the January

retail sales

report, due out Friday at 8:30 a.m. EST.

The weekly

Mortgage Applications Survey

detected increases in both refinancing and new mortgage activity. The Refinancing Index rose to 436.7 from 384.4, while the Purchase Index rose to 307.1 from 292.6.

Currency and Commodities

The dollar weakened against the yen and the euro. It was lately worth 109.00 yen, down from 109.51 yesterday. The euro was lately worth $0.9930, up from $0.9854 yesterday.

Crude oil for March delivery at the

New York Mercantile Exchange

fell to $28.60 a barrel from $28.02 yesterday.


Bridge Commodity Research Bureau Index

advanced to 212.64 from 210.38 yesterday.

Gold for April delivery at the


gained sharply again, to $308.50 an ounce from $301.70 yesterday.