Treasury prices closed lower yesterday, with intermediate-term notes posting the biggest losses, as new supply weighed on the bond market.
Late in the day, intermediate-term notes were down as much as 1/4 point, while the 30-year bond was off only 1/32 and yielded 7.60%.
The intermediate area of the curve fared the worst because it had to absorb not only the $9.77 billion of new seven-years auctioned by the Treasury, but some hedging of new corporate issues as well, traders said.
Treasury prices moved higher overnight, then gave back those gains and moved into negative territory on a wave of selling in early New York trading.
The market continued to inch lower through the morning session as dealers built in a concession ahead of the note auction, then hit session lows in the interval between the bidding deadline and the time the results were announced.
A note trader said there was "a lot of negativity" as the market waited for the auction results.
"People got a little nervous and backed [the when-issued notes] up to 6.47%," up from the 6.44% level when bids went in, a coupon trader said. "Then the results came out and they weren't all that bad."
In fact, the auction results were exactly what the market had expected.
The seven-year notes were sold at an average yield of 6.44% and will bear a 6 3/8% coupon.
That compares with the 7.11% yield and 7% coupon at the last seven-year sale in April.
Some securities were awarded at a high yield of 6.45%. The 6.44% average yield and 6.45% high were exactly what the market expected at auction time.
As Treasury prices improved after the auction results came out, the yield on the when-issued seven-years fell back to the 6.44% auction average from the session high of 6.47%.
William Sullivan, director of financial market research at Dean Witter Reynolds Inc., said yesterday's sale was a "quintessential" seven-year auction, with the 2.32 bid-to-cover ratio, one-basis-point tail, and $591 million of noncompetitive bids all in line with the averages for seven-year sales.
Mr. Sullivan said the auction benefited from investors who were moving funds out from the short end in search of higher yields. "Most of the interest came on swaps from twos and fives," he said.
Traders said the heavy issuance in the corporate market was another negative for the Treasury market yesterday.
More than $2 billion of corporate bonds were priced yesterday, following the huge $4 billion of securities priced Tuesday.
Treasury Market Yields
Wednesday Week Month
3-Month Bill 3.28 3.61 3.75
6-Month Bill 3.37 3.72 3.92
1-Year Bill 3.60 4.02 4.18
2-Year Note 4.36 4.81 5.07
3-Year Note 4.87 5.29 5.62
4-Year Note 5.91 6.23 6.56
5-Year Note 5.91 6.23 6.57
7-Year Note 6.41 6.66 6.96
10-Year Note 6.88 7.07 7.34
15-Year Bond 7.24 7.41 7.62
30-Year Bond 7.60 7.74 7.89
Source: Cantor, Fitzgerald/Telerate
Some of the new deals reportedly were languishing, and that hurt Treasury prices because corporate dealers often hedge unsold inventories by establishing short positions in Treasuries.
"There was definitely some hedging going on," the note trader said.
He said corporate hedging was to blame for the 10-year note's dismal performance and pointed out that the 10-year had underperformed the seven-year notes on a day when seven-years were being auctioned.
Traders said the market will spend the rest of this week distributing the new supply and keep one eye on the economic news.
Upcoming indicators include today's weekly jobless claims and money supply statistics and tomorrow's June producer price report.
The weekly total for new unemployment claims stalled out in April and May after moving lower in February and March. The bond market will be watching to see if the report gives any confirmation of the weakness in last week's June employment report.
The consensus forecast is for a 417,000 total in the week ended June 27, down from 420,000 the previous week.
Looking ahead to tomorrow, traders are worried the producer price report will show signs inflation is reviving, but most analysts are expecting a friendly report.
A dozen economists surveyed by The Bond Buyer on average expect a 0.2% gain in the index and no change in the core rate, excluding food and energy costs.
But Mr. Sullivan said the numbers might not have much impact. Tmarket is interested in jobless claims, but the price reaction will be limited by the fact that it is only one week's worth of information, and the producer price report has less importance as a policy guide because the Fed just cut key rates, he said.
"I think the market will drift, and there may be a tendency to take profits in an overbought environment," Mr. Sullivan concluded.
A coupon trader said the market's selloff yesterday afternoon hurt psychology and will prevent any further price improvement in the short-term.
"Some people who are owners above the market are thankful we recovered and are now looking to get out," the trader said. "It just puts a temporary lid on prices while those people exit."
The September bond futures contract closed 1/32 lower at 102 19/32.
In the cash market, the 30-year 8% bond was 1/32 lower, at 104 16/32-104 20/32, to yield 7.60%.
The 7 1/2% 10-year note fell 9/32, to 104 7/32-104 11/32, to yield 6.88%.
The three-year 5 7/8% note was down 1/16, at 102 18/32-102 20/32, to yield 4.87%.
Rates on Treasury bills were higher, with the three-month bill up three basis points at 3.23%, the six-month bill up two basis points at 3.29%, and the year bill two basis points higher at 3.48%.