5-Year Treasury Note Auction "A Stinker"

Bill Gross, founder and co-chief investment officer, of bond fund giant PIMCO called today's auction of 5-year Treasury notes "a stinker"." And that it was. Bloomberg's report:

Highlights
A huge five-basis-point tail mars December's $35 billion 5-year note auction. The high yield of 2.149 percent compares with a 2.102 percent when-issued yield at the 1:00 bidding deadline. Non-dealer participation wasn't quite as soft as yesterday's 2-year auction with the group awarded 42 percent vs a 45 percent average. This week's Treasury's auctions are definitely showing the effects of thin holiday conditions. The Treasury auctions $29 billion of 7-year notes tomorrow.

Notice that there is a 7-year note auction tomorrow. Today's market pushed the benchmark 10-year Treasury yield up almost 15 basis points to 3.48%.

Previous post: how to follow Treasury Auctions.

Nasty Day in the Bond Market

Yesterday the yield on the 10-year Treasury note popped 12 basis points from 2.60% to 2.72%. As recently as last Thursday, this yield was at 2.53%.

Yesterday's upward push came as the U.S. Treasury auctioned off $24 billion in 10-year notes.

And, actually, the results of the auction were fairly good. Here's Bloomberg's assessment:

The 10-year note auction stopped out one basis point under the 1:00 ET bid, showing strength in line with the last four 10-year auctions. Coverage of 2.80 is strong yet is the lowest showing of the last nine auctions. Strong non-dealer participation is a big positive as dealers were awarded only 34 percent of the auction for the lowest share of the last six auctions. Money is moving into the Treasury market following the results.

The big question, of course, is whether this is the bursting of the much-discussed bond bubble.

We are past the news on Quantitative Easing II. We know the Federal Reserve's time frame and that they intend to buy up to $600 billion. We've seen some Fed governors expressing doubt about the efficacy of the move. We know that there is well-respected voluminous empirical evidence supporting economic theory that states that printing money is inflationary and non-beneficial to the real economy in the long run.

It reminds long-term observers of the macro economy during Nixon's price controls. Economic theory and evidence clearly shows that price controls lead to distortions that increase the longer they are in place. Yet Nixon's economic team somehow didn't understand this. Once the controls were lifted, inflation took off.

Today the Treasury auctions the 30-year bond. Its yield is up to 4.25% after dipping below 4% earlier in the month. It should be an interesting auction. If you can't wait for the results, tune into CNBC shortly after 1 pm.

As they used to say on Hill Street Blues, "Be careful out there."

The Circus is in Town

Recently I went over how to follow Treasury auctions by going to the Bloomberg site's calendar. Yesterday the Treasury auctioned the 30-year Treasury, and it didn't go well. Bloomberg reported:

"Coverage of 2.49 was soft for today's $13 billion reopening of the August 3.875 percent 30-year bond. The auction shows a larger than usual two-basis-point tail, stopping out at 3.852 percent vs. a 1:00 p.m. ET bid of 3.834. Buyside interest was soft with dealers taking down an outsized 59 percent of the auction, more than 10 points above average. Demand for Treasuries is slipping following the results which wind up a heavy week of uneven auctions. "

Some commentators are saying that the Chinese protested and didn't participate because of a report that may declare them a "currency manipulator" was delayed.

These are the kinds of events that change market sentiment and are worth following. Of course, in the background, the nev---ending circus in the nation's mortgage market goes on--this time with possible serious property rights violations.

This reminds me of e.e. cummings and "everything damned but the circus" which always gets me to smile in crazy situations.

The Rise in Treasury Bond Rates

Do-it-yourself investors are closely watching Treasury bonds and wondering whether the recent rise in yields is the beginning of the often forecasted upward move or merely a blip that will shortly reverse. As part of this process, observers pay careful attention to the Treasury bond auctions. As shown on the Bloomberg calendar, this past week has been a heavy week in Treasury issuance, culminating with yesterday's 30-year Treasury (the so-called "long bond") auction. The results, as reported by Bloomberg, were not so good:

Results are very weak for the monthly 30-year bond auction which tailed by two basis points. The auction stopped out at 3.820 percent vs. a 1:00 ET bid of 3.798 percent. Coverage wasn't bad at 2.73 but dealers got stuck holding a 55 percent share of the $13 billion offering, the largest share in nearly a year. Given the recent run of less downbeat economic news, today's results point to investor expectations that rates at the very long end may begin to rise. Demand for Treasuries is easing following the results.

To gain some perspective on yields, a useful source is the "Daily Treasury Yield Curve Rates" published by the U.S. Treasury.

Treasury issuance, although a big part of the puzzle, is not the only part- there is also supply from other areas. In the corporate sector:

Investment-grade companies issued $33.1 billion of new notes on Tuesday and Wednesday, with the latter's $19.2 billion one-day total the highest daily volume for U.S. high-grade bonds in 19 months, according to data provider Dealogic (Holdings) PLC.

Alas, nobody said this was easy. In effect, we are trying to put together a puzzle where we don't have the picture on the box. My feeling is that yields will go a bit higher - 10-year yield slightly above 3% - but the overriding factor will be, as always, how the economic data plays out.

Where do you think yields are headed?

Related post: When Will Interest Rates Rise?

Interest Rate Watch - 7 Year Treasury Auction

By now this is routine. Using the method described in Monday's post, we can go to Bloomberg site and the economic calendar. They assess the auction as follows:

Highlights
The 7-year auction proved the best in a week of heavy supply in light holiday conditions. Coverage of 2.98 is up from last month's 2.78, both auctions $29 billion in size. Buyside interest was solid with non-dealer bidding at 65 percent vs. a 62 percent average. With a high yield of 1.989 percent, the auction stopped out one basis point below the 1:00 ET bid.

Clearly the results were strong and Treasury was able to move in excess of $100 billion in Treasury notes at low yields. Note that the strongest leg of the three-part auction was the longest maturity.

Now all eyes turn toward Jackson Hole Wyoming to listen to Fed Chairman Bernanke to garner clues for the Fed's plan to get us out of this mess.

Interest Rate Watch - 5 year Treasury Auction Results

Continuing with the Treasury auction results, going to the Econoday calendar at the Bloomberg site as described in Monday's post, we get the following comments on yesterday's Treasury note auction. This is the second leg of a three-part issuance, totaling in excess of $100 billion.

Highlights
Thin late August markets are making for soft Treasury auctions. Coverage for today's $36 billion 5-year auction was solid at 2.83 but the offering size was the smallest of the year at $36 billion. The auction shows a one basis point tail, posting a stop-out rate of 1.374 percent vs. a 1:00 bid of 1.365 percent. Buyside participation was respectable with non-dealers taking 57 percent of the auction, only slightly lower than the July auction. The Treasury closes out another heavy week of supply tomorrow with a $29 billion 7-year auction.

It looks like non-competitive, non-dealer buying was a bit heavier, indicating that individuals are stretching a bit for yield. Still, at 1.375% yield, the after-tax real yield (subtracting for inflation) is negative. This issue came with a coupon of 1.25% and, therefore, because it had a yield of 1.3774%, was sold at a discount. This is now the so-called "on-the-run" 5-year Treasury note. Using the same drop down list as for the calendar and clicking on "Rates & Bonds" gets you to a complete list of on-the-run issues and what is called the "Treasury Yield Curve": Click Image to Enlarge. Note the discounted price of the new 5-year and its yield-to-maturity of 1.37%.

Treasury returns versus maturity

Many DIY investors are not really comfortable with bonds and how they work. This is unfortunate because bonds are obviously an important component of the portfolio and become more important for most DIY investors as they age.

How Bonds Work
Simply, bond prices and yields move in opposite directions. Because longer maturity bonds tend to have more future payments, their price tends to move around (i.e. is more volatile) more than shorter maturity bonds.

Total return over time includes the change in price plus the interest earned. Total returns for various maturity Treasury issues are shown in the graph (Click Graph to Enlarge)produced by Econompicdata . The bottom solid line is called the "yield curve". The yield curve is a snapshot at a point in time that shows the yields, by maturity, for a given class of bonds. For example, instead of Treasury issues, a yield curve could be drawn for single A corporate bonds. Typically, the curve slopes upward as shown in the graph. This reflects the greater volatility of longer maturity bonds. If the curve slopes downward, it is called an "inverted yield curve" and usually presages an economic downturn.

Year-to-date Results
The interesting part of the graph produced by Econompicdata is the returns by maturity. As a benchmark, the yield on the 10-year maturity U.S. Treasury note dropped from 3.84% to 2.70% for the period shown. This produced a total return in excess of 14% for the 10 year maturity - great offset to a weak stock market environment and definitely helpful for giving investors a good night's sleep. Notice that the longer maturity issues had greater return--that is, the more risk you took in the bond market, the greater the reward.

Kudos to Econompicdata for this chart.