Five-Year Note Auction Is a Hit, But Long-Term Prices Fall a Little

Long-term Treasury prices closed slightly lower for the second session in a row yesterday, as some participants bet the yield curve is likely to steepen, not flatten.

The price declines occurred even though yesterday's auction of five-year notes went well.

By late in the afternoon, most Treasury note and bond prices were slightly lower, with the 30-year off 1/8 point to yield 7.89%.

"People think the curve is going to steepen out even more," a government bond trader said. "So they're selling the long end and buying the short end."

Hopes for a near-term easing by the Fed, as well as early worries about upcoming supply at the long end, including next month's seven-year notes and November's refunding auctions, support the notion the curve will steepen, traders said.

A note trader said the short end is also attractive right now because quarter-end pressures were causing it to underperform, as some participants dumped short-term paper to tidy up their balance sheets.

"I think once the new quarter comes, you're going to get a nice pop" at the short end, he said.

Steven Wood, director of financial markets research at Bank of America, said economic fundamentals do not support the notion of a steeper curve.

"We have a fairly steep curve already, a fairly sluggish economy, and restrained inflation," Mr. Wood said. "I don't think there's any particular reason for a steeper curve."

He suggested the Treasury market was just drifting aimlessly while participants waited to see whether the Fed will cut rates again.

The optimism about another Fed easing gave a boost to yesterday's five-year sale.

The $9.3 billion of notes came at an average yield of 7.05% and will bear a 7% coupon, the lowest rate at a five-year sale since February 1987.

The 7.05% average matched where the notes were trading at the bidding deadline. Other auction statistics that showed a decent demand for the securities included the $737 million of noncompetitive bids and the total amount of bids, which was more than three times the size of the issue.

"I don't think there was any trouble getting the five-years done at all," Mr. Wood said.

The decline in New York's share of winning bids that showed up at Tuesday's two-year sale was reversed yesterday. Bidders in New York were awarded 92% of the notes, close to the average of 93.4% in recent auctions.

The new five-years backed up with the rest of the market yesterday afternoon and were bid at 7.07% late in the day.

Prices sold off briefly in early New York trading when August durable goods orders came in stronger than expected.

New orders for durable goods declined 3.8% in August, but economists had expected orders to fall more than that in a rollback from July's surge.

The change in July orders was revised yesterday to a 11.7% gain from the 10.7% reported last month.

Stephen Gallagher, an economist at Kidder Peabody & Co., said averaging the two months' numbers shows the manufacturing sector is recovering at moderate pace, as many other statistics have indicated.

"The manufacturing sector appears to be on a typical recovery pattern," Mr. Gallagher said. "It's the service sector and construction that are lagging behind."

Peter D'Antonio, an economist at Citibank, said the growth in durables looked slow if aircraft orders are excluded. Without aircraft orders, new orders were flat in August after rising 2.2% in July.

He said the 0.1% decline in unfilled orders, excluding aircraft, was also worrisome, since it suggests manufacturers are filling previous orders faster than they're getting new ones, which is a bad sign for future production plans.

An unexpected drop in August existing home sales that was reported later in the morning helped the Treasury market come off its lows.

The 2.1% drop in August home resales, to a 3.25 million unit annual rate, which follows a 6.7% decline in July, confirmed that momentum in the housing market has slowed.

The December bond future contract closed 1/8 lower, at /32.

In the cash market, the 30-year 8 1/8% bond was 5/32 lower, at 102 15/32-102 19/32, to yield 7.89%.

The 7 7/8% 10-year note fell 1/16, to 102-102 4/32, to yield 7.56%.

The three-year 6 7/8% note was down 1/32, at 101 8/32-101 10/32, to yield 6.36%.

In when-issued trading, the 6 1/8% two-year note was 1/32 higher, at 100-100 1/32, to yield 6.10%, down from the 6.14% average at Tuesday's auction.

Rates on Treasury bills were mixed, with the three-month bill down two basis points at 5.17%, the six-month bill off one basis point at 5.21%, and the year bill steady at 5.22%.

Table : Treasury Market Yields

Prev. Prev.

Wednesday Week Month

3-Month Bill 5.30 5.31 5.44

6-Month Bill 5.41 5.44 5.52

1-Year Bill 5.50 5.53 5.64

2-Year Note 6.10 6.16 6.29

3-Year Note 6.36 6.44 6.62

4-Year Note 6.56 6.59 6.77

5-Year Note 7.05 7.07 7.29

7-Year Note 7.37 7.39 7.62

10-Year Note 7.56 7.59 7.80

20-Year Bond 7.78 7.85 7.97

30-Year Bond 7.89 7.91 8.05

Source: Cantor, Fitzgerald/Telerate

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