The entire Treasury market got a boost yesterday when the Federal Reserve let the market know it was easing short-term rate as dealers prepared to bid on the first leg of the quarterly refunding, $14 billion of three-year notes.
The market sailed through the auction and prices closed near the day's highs, with the 30-year bond up 1/2 point to yield 8.17% -- the lowest closing yield in three months.
"So far, so good," said Robert Brusca, chief economist at Nikko Securities Company International. "The Fed easing on the first day of the refunding certainly provided a bit of a buoyant tone."
But he cautioned that "the refunding's success or failure depends on what happens Thursday, not Tuesday," referring to the riskiest of the three refunding auctions, tomorrow's sale of 30-year bonds.
The Fed easing move surprised the market. Although analysts agreed that the chances of another Fed easing increased greatly after Friday's July employment report showed 51,000 jobs were lost last month, most thought policy was on hold until the Aug. 20 Federal Open Market Committee meeting.
"It looks as though they're getting a little nervous," said Henry Engler, an economist at Chemical Securities.
"The decline in monetary growth we've seen in July, irrespective of how you try to explain it, does not bode well for future economic activity," Mr. Engler said. "That, coupled with the [July] employment report, was enough evidence to cause them to re-evaluate their own forecast."
The Fed signaled it was easing its funds target by adding reserves to the monetary system with overnight system repurchase agreements.
"Without a doubt it was an ease," said Michael Moran, chief economist at Daiwa Securities America. "This is as clear a signal as you will ever get from the Federal Reserve."
Analysts said the Fed likely lowered its target by 25 basis points, to 5 1/2%, since it usually moves in 1/4-point increments. But they said they cannot be certain about the new target until they see how funds trade and what the Fed does over the next few trading sessions.
The market traded up into the auction, with the three-year notes, which were trading at 7% before the Fed signaled it was easing, at 6.90% by the bidding deadline.
In retrospect, that yield was a bit too ambitious. The auction results showed the notes came at an average yield of 6.92% and will bear a
Treasury Market Yields
Prev. Prev.
Tuesday Week Month
3-Month Bill 5.56 5.70 5.74
6-Month Bill 5.69 5.91 5.94
1-Year Bill 5.87 6.20 6.27
2-Year Note 6.56 6.80 6.94
3-Year Note 6.86 7.15 7.39
4-Year Note 7.02 7.29 7.58
5-Year Note 7.53 7.78 7.99
7-Year Note 7.79 8.02 8.23
10-Year Note 8.15 8.17 8.35
20-Year Bond 8.20 8.33 8.52
30-Year Bond 8.17 8.36 8.52
Source: Cantor, Fitzgerald/Telerate
6 7/8 of coupon, down from the 7.09% yield and 7% coupon at the last three-year sale in May.
The 6.92% average was in line with expectations, but traders were surprised that some bids were accepted at 6.93%. Still, only 17% of bids submitted at the level were accepted.
Other statistics showed demand at the auction was good, but not outstanding. The bid cover was average for a three-year sale, with 3.1 bids entered for every bond to be sold. None-competitive bids, mostly the province of small investors, totaled $1.053 billion, also about average for this auction.
Japanese investors reportedly took much less than their usual 25% to 30% yesterday. Some estimates put the Japanese share at as little as 10% of the three-years.
Traders said a strong demand for paper sustained the market all through the session yesterday, suggesting the remaining refunding auctions will also go well. The Treasury will sell $12 billion of 10-year notes today and $12 billion of 30-year bonds tomorrow.
"We had good buying before [the Fed] came in, we had good buying after they came in," a note trader said. "There's a good chance we can plough through these auctions without that much of a pull-back."
A government securities salesman agreed there had been a lot of buying, but said some of it was from dealers covering short positions.
That still reflects retail buying, since selling to retail is how the dealers established the short positions in the first place, he said. But since retail investors have already purchased a lot of securities and dealers have covered their short positions, he questioned what dealers would do with the paper they bid on at the remaining auctions.
"The auctions probably will do all right at this level," the salesman said. "There's just a heightened degree of concern about where the Street will put what they take here."
He added, though, that today's sale of 10-year notes could be a "really screaming success" given the recent interest in intermediate securities.
Economists said investors may also be attracted to Treasury paper because they expect more Fed easing down the road.
One reason to expect more easing is that if the Fed eased funds 25 basis points, to 5 1/2%, the funds rate would now be at the same level as the discount rate.
The funds rate traditionally trades above the discount rate, although economists pointed out that the Fed left the two rates at the same level for almost two months earlier this year.
Still, analysts said they expect the Fed will eventually lower the discount rate, in part because they do not think a 1/4-basis-point cut in fund is enough to kick-start the recovery.
"We think that the economy is anemic enough so that 25 basis points in Fed funds won't really help," Ms. Murphy said. "We believe the Fed will indeed lower the discount rate to 5% at some future date."
The September bond future contract closed 5/8 higher, at 96 23/32.
In the cash market, the 30-year 8 1/8% bond was 9/16 higher, at 99 11/32-99 15/32, to yield 8.17%.
The 8% 10-year note rose 13/32, to 1005/32-100 9/32, to yield 7.95%.
The three-year 7% note was up 7/32, at 100 8/32-100 10/32, to yield 6.86%.
In when-issed trading, the new 6 7/8% three-year note was quoted at 6.93%, off slightly from the 6.92% average at the auction.
The when-issued 10-year to be auctioned today was quoted at 7.95%, and the 30-year to be sold tomorrow stood at 8.15%.
Rates on Treasury bills were sharply lower, with the three-month bill down nine basis points at 5.42%, the six-month bill of 11 basis points at 5.47%, and the year bill down 13 basis points at 5.56%.
