Treasury prices fell sharply yesterday afternoon as the dismal reception for the three-year note sale cast doubt on the amount of demand for the two remaining refunding auctions this week.
Late in the afternoon, the 30-year bond was more than a point lower and yielded 8.02%. The price of the new three-year notes had fallen enough to push their yield up to 6.06% from the 6% average at the auction.
The three-year note is traditionally the most successful of the three refunding sales, and short-term securities in general have been popular lately because of the repeated easings by the Federal Reserve.
Traders and analysts said the market's disappointment when the Fed failed to cut the discount rate yesterday was one reason the auction went badly.
Worries about the two remaining auctions and the uncertainties caused by recent Treasury rule changes and the Salomon scandal may also have been to blame, they said.
The 6% yield was weaker than the market's estimate of a 5.99% average. Even worse was the fact that accepted bids tailed all the way back to 6.03%, when the market thought notes would only be awarded to hidders at 6%, or perhaps 6.01%.
"It was really a horrible auction," said Steven Slifer, a money market economist at Lehman Brothers.
He pointed to the $21.8 billion of bids entered at the auction, which is a scant 1.6 bids for each security being sold. The three-year sale usually draws three bids for each security being offered.
A Treasury official said it was the lowest bid-to-cover ratio at any Treasury auctions since April 1981.
And even though the Treasury loosened its limits on noncompetitive bids, they totaled only $852 million yesterday, below the average for three-year sales.
The market was a little nervous after the bids went in and prices dipped, but it sold off in earnest once the results werannounced.
The auction results were "a complete surprise," a government coupon trader said.
"There was supposedly a lot of interest in the auction and it all backed away at the last minute," he said. "The issue in my mind was
Treasury Market Yields
Tuesday Week Month
3-Month Bill 4.87 5.01 5.13
6-Month Bill 4.88 5.10 5.26
1-Year Bill 5.05 5.16 5.30
2-Year Note 5.69 5.76 5.88
3-Year Note 5.01 6.05 6.13
4-Year Note 6.13 6.20 6.32
5-Year Note 6.78 6.78 6.81
7-Year Note 7.19 7.15 7.16
10-Year Note 7.54 7.48 7.42
15-Year Bond 7.86 7.73 7.71
30-Year Bond 8.02 7.89 7.81
Source: Cantor, Fitzgereld/Telerate expensive to begin with and I guess everbody realized it at the last minute."
The trader said ted Fed's failure to cut the discount rate yesterday may have helped people realize the issue was too expensive.
Traders assume the Fed will not alter monetary policy while the refunding is going on. And since it failed to act yesterday, many economists think the next chance for an ease will be late next week, after Fed policymakers have seen October producer prices next Wednesday, producer prices next Wednesday, Nov. 13, and retail sales and consumer prices Thursday, Nov. 14.
Johnson Smick International, the Washington consulting firm, reportedly chimed in along those lines yesterday morning, telling its clients that the Fed would wait to ease until nearer to Fed Chairman Alan Greenspan's reconfirmation hearings, which begin Tuesday, Nov. 19.
Since the short end had already priced in a Fed move, "the auction was mispriced," Mr. Slifer said. "I don't think people found the yield on it particularly attractive.
Robert Brusca, chief economist at Nikko Securities, said investors may have been wary of buying anything ahead of tomorrow's bond auction, given the 30-year's poor performance recently.
"If the 30-year auction goes crummy, you're going to wich you didn't buy the threes and didn't buy the 10s," Mr. Brusca said, adding that he thought the market would begin to improve once the bond auction is out of the way.
Opinion was divided on what yesterday's results meant for the 10-year auction tomorrow and the 30-years year sale Thursday.
Since bidding errors are much costlier at auctions of longer-term securities, Mr. Slifer said yesterdays's experience would make dealers very cautious.
Still, he said, "given the shape of the curve, the longer auctions should be more appealing to investors."
And the note trader said that although investors usually splurge at the three-year sale and have no money left to buy 10s and 30s, "this could be the reverse."
Matthew Alexy, a money market economist at Deutsche Bank Government Securities, was not so optimistic. "People argue some investors want to extend out, but if that's what they want to do, they won't do it at the auctions."
The December bond future contract closed 21/32 lower at 98 22/32.
In the cash market, the 30-year 8 1/8% bond was 1 3/32 lower, at 102. 4/32-103 28/32, to yield 8.02%.
The 7 7/8% 10-year note fell 1/2, to 102 4/32-103 28/32, to yield 7.54%.
The three-year 6 7.8% note was down 1/4, at 102 3/32-102 5.32, to yield 6.01%.
In when-issued trading, the 30-year bond to be sold tomorrow was bid at 8.01% and the 10-year note to be sold today was quoted at 7.53%.
Rates on Treasury bills were higher, with the three-month bill up two basis points at 4.76%, the six-month bill up one basis point at 4.81%, and the year bill six basis points higher at 4.82%.