Treasuries Get Out of AT&T's Way

The Treasury market spent most of the day gawking at the $7 billion colossus of debt launched by AT&T (T) - Get Report this morning. As the day waned, an oil rally sideswiped the market, sending it lower after spending most of the session a few ticks away from unchanged.

"We're like deer, staring into the headlights of the oncoming AT&T deal," said Mitch Stapley, who oversees $2.5 billion in taxable fixed income at

Kent Funds

in Columbus, Ohio.

Treasury bonds popped higher this morning when the $7 billion deal was announced. The size was a bit of relief to the market, which had been preparing for a possible $8 billion to $10 billion offering. (AT&T filed a $13.08 billion shelf with the

Securities and Exchange Commission

).

Tracker

GovPX

reported volume down 37% when compared to the average first-quarter Monday, as only $38.8 billion in bonds exchanged hands. Only in the afternoon did volume pick up as a response to the rise in oil prices.

After the initial spike in bond prices, the market settled in for a day of range trading. But around 2:30 p.m. EST, oil prices rose sharply, sending bonds down. April crude oil, which opened at $15.30, rose to $15.60 before closing at $15.50, and it caused the June bond contract to close down 10/32 to 120 28/32. The 30-year Treasury bond, meanwhile, recovered a bit and was lately down 4/32 to 95 12/32, yielding 5.569%.

"The market couldn't hold on

to its gain," said Ken Fan, bond strategist at

Paribas Capital Markets

. "Going forward, it's still going to be about supply. We also have $15 billion in two-year

Treasury notes. Prior to Wednesday we have no economic releases, and so it's going to depend on how the deals are distributed."

The AT&T deal, if successful, would be the largest corporate issue ever sold, besting the $6.1 billion sold by

MCI Worldcom

(WCOM)

last summer. The proceeds of this issue will be used, in part, to pay for the company's recent merger with

TCI

. AT&T plans to sell at least $10 billion in debt (comprising this deal and a future offering), but could easily increase the size of this offering due to the overabundant demand this offering should produce.

Generally, there's a flurry of selling in the days leading up to issuance, both by underwriters executing so-called "rate lock" trades and from investors making room in their portfolios. A rate lock is an underwriting practice that involves selling bonds at the behest of the company to protect against rising interest rates as the upcoming deal is marketed. If rates rise in the interim, the cost to issue bonds is greater, but the underwriter buys back the Treasury bonds at a lower price, and profits from the earlier sales.

"People are keeping a close eye on this, but the deal has been premarketed for a while," said Richard Schwartz, portfolio manager in the stable value group at

New York Life Asset Management

. "As the transaction begins, when

underwriters sell the issue they'll buy Treasuries back. With this deal, that's a lot of buying."

The offering is split into three tranches, or pieces. The smallest is $1.75 billion in five-year notes, and price talk is at 65 basis points greater than the comparable Treasury note. In addition, $2.5 billion in 10-year notes will be sold, with talk at 85 basis points over the Treasury, and $2.75 billion in 30-year bonds, with talk at 95 basis points over the Treasury. The deal is expected to price tomorrow, perhaps in the morning.

This AT&T deal alone will comprise at least 0.1% of the

Lehman Aggregate

bond index, based on the aggregate value of the index, which at the end of November stood at $5.4 trillion. Lehman officials did not return a call seeking comment. But Stapley thinks that facet of the deal has been overemphasized, and that the underwriters are pricing the deal too rich as a result.

"We've gotten to the point where we're not selling on cheapness versus Treasuries or other people in the same sector, but because of the total AT&T debt in the index, which means everybody will have to own it," said Stapley, who isn't going to buy the bonds. "Plus, it's going to be the 'new' liquid benchmark. This is priced rich, so they're trying to justify it in that way, and I think it's time to step back."