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Like Fish to Water, Traders Are Drawn to Liquidity

Liquidity remains very much in vogue in the bond market.

The latest indication of that came this morning, with the


quarterly refunding announcement. The quarterly refunding -- a series of auctions of new five-year notes, 10-year notes and 30-year bonds -- will take place next Tuesday, Wednesday and Thursday. This morning, the Treasury announced the size of each auction.

There were no real surprises. The fourth-quarter refunding will be a little bigger than the third-quarter one, but at $38 billion it's not as big as some had feared it would be. (Weak supply helps support prices.) At the last refunding, $16 billion of five-year notes, $11 billion of 10-year notes and $10 billion of 30-year bonds were issued. At the next one, the only change will be $12 billion of 10-year notes.

The indication that liquidity remains extremely important to investors is in what traders call the "rolls." As soon as the Treasury announces the size of the new issues, traders start trading them. They don't exist yet, and traders don't know what size coupon the Treasury will decide to attach to them come auction day, so they trade by yield rather than by price. It's called when-issued trading.

The rolls represent the difference in yield between the most recently issued notes and bonds and their when-issued counterparts. This time they are wider than usual, indicating a stronger-than-usual preference for what will be the newest issues next week. In Treasury trading, the most recent issues are always the most liquid.

For example, a few minutes ago, the five-year Treasury note was up 2/32, its yield 4.20%, while the when-issued two-year note was yielding 4.17%. Normally,

First Chicago Capital Markets

trader Tom O'Connell said, the when-issued five-year can be purchased at a yield slightly higher than the most recent issue's, since its maturity is a bit longer.

Likewise, for the two-year notes that the Treasury will auction today (a new two-year note is auctioned every month), the most recent issue was lately down 1/32, its yield 4.11%, while the when-issued two-year was trading at a yield of 4.04%. Normally, O'Connell said, the two-year roll is 2 to 3 basis points, meaning that an investor can buy the when-issued note at a yield 2 to 3 basis points lower than the current issue.

The fat rolls suggest that "people don't view the liquidity crunch we've seen as over," O'Connell said.

Before today, indications that investors prize liquidity have been evident in everything from wider-than-usual yield spreads between current Treasury issues and older ones to still-suffering demand for bonds other than Treasuries, which are much less liquid.

Between the two-year auction, next week's refunding and the pricing a few minutes ago of a $3 billion five-year note by

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, supply is the dominant concern in the Treasury market today.

A key economic report was significantly stronger than anticipated, but the reaction to it was mild. September

durable goods orders

rose 0.9%. Economists surveyed by


were looking for a 0.7% drop on the heels of August's 2% gain. And excluding volatile transportation orders, which fell 4.4%, orders rose 2.6%.

"I expected to see the market sell off more" on the news of strength in the manufacturing sector in spite of the widening trade deficit,

Stone & McCarthy

Treasury market analyst John Canavan said. "We've seen such thin trading today. Everyone appears to be sidelined. I think that's the reason we've been able to hold in here."

At about 11:15 a.m. EDT, the benchmark 30-year Treasury bond was down 16/32 at 105 22/32, its yield rising to 5.13%.

Expectations as reported by