Treasuries lost ground yesterday as tepid demand for the first of the week's three Treasury auctions dampened prospects for a successful August refunding.
The 30-year bond closed down more than 1/4 of a point, to yield 7.56%, while the two-year note was unchanged at a yield of 6.20%.
The market recouped some of its losses late in the session as a report on retail sales suggested slower consumer spending activity, but the disappointing auction results dominated trading.
The Treasury awarded $17 billion of three-year notes at an average yield of 6.61%, one basis point above market expectations. The high yield was 6.62%.
The bid-to-cover ratio of 2.59-to-1 was higher than the average of the last 12 three-year auctions but lower than market expectations. The same was true of non-competitive bids, which were well above average at $1.318 billion but came in below market expectations of $1.5 billion.
Participants found the three-year results discouraging because that auction was expected to be the strongest of the three. The 10-year and 30-year auctions are thought to be significantly tougher sells than the three-year.
"The three-year was thought to be the easiest to get done, and after it came in below expectations, people were worried that the 10-year and 30-year auctions wouldn't go so well," said Elias Bikhazi, money market economist at Deutsche Bank Securities Corp.
Bidding at the auction was weaker than expected, suggesting that retail investors remain wary of the issue given expectations that the Federal Reserve will hike short-term rates next week, dealers said.
Dealers said it was clear from the detail of the auction results that accounts avoided bidding aggressively on the three-year in hopes of buying the issue cheaper once the central bank tightens.
The Treasury market came under pressure early yesterday as dealers anxiously awaited the first of this week's refunding auctions, which will help set the tone for trading in coming sessions.
Issues throughout the maturity spectrum came under selling pressure as dealers closed out existing positions and established new short positions. The worry among participants is that tepid demand for new government paper will send prices lower.
The Treasury this week is selling $40 billion of notes and bonds, with the second leg coming this afternoon when dealers will bid on $12 billion in 10-year notes.
On the economic statistic front, the Johnson Redbook Service reported that retail sales in the first week of August were down 0.7% from the July rate, lending support to the view that the economy is slowing in the second half of the year, analysts said.
The outlook for the remainder of the refunding auctions is mixed. While market sentiment remains decidedly negative, some participants believe Treasury yields have backed up enough to allow a decent bidding environment for the issues.
Treasury market participants are anxious to get a read on investor demand for fixed-income securities. Interest rates, they argue, have backed up significantly in recent sessions and have presented investors with attractive yield levels. Furthermore, many market observers are stoic in their belief that economic growth will slow in the second half of the year.
However, the outlook for the auctions has been clouded by the increasing likelihood that the Federal Reserve will raise short-term interest rates next week. Throwing further uncertainty into the mix are a number of crucial economic reports due out this week, including the July producer and consumer price reports and July retail sales.
Bankers Trust economist Joshua Feinman believes that faced with contrasting data, the Fed will likely err on the side of tightening, noting that chairman Alan Greenspan has said as much. Given the thin margin of slack remaining in the labor and product markets, the Fed's tolerance for growth much in excess of the economy's long-run potential is, and should be, razor thin, he said.
"Absent clear, concrete evidence that economic growth is slowing to a 2 1/2% to 3% range right now, the Fed will continue to tighten in a pre-eruptive attempt to preserve the current tranquil inflation backdrop," Feinman said.
Convincing retail accounts to buy Treasuries in such an environment will be a formidable challenge, analysts agree. Against that backdrop, market analysts expect a concerted effort by the primary dealers to build a concession into the market to gain the interest of retail accounts.
While some fixed-income observers believe that Friday's steep sell-off may have backed yields up enough to ensure buying interest at the refunding, most think that demand for the two remaining legs will be hampered by uncertainty over what the Fed will do.
"It was obvious from the three-year results that even the big backup in rates we've had wasn't enough to stir interest from buyers," a coupon trader said.
Most market observers think the 10-year note will be the toughest sell this week, particularly because it will be sold on the eve of potentially market-moving economic figures and one week before many expect the central bank to tighten.
On the other hand, the issue could benefit from the recent backup in rates and the abundance of short positions that have been established in anticipation of further price declines ahead of the auctions, some observers said.
The 30-year bond is the wild card of the August refunding, analysts said. The long bond is widely thought to be the issue that has the most to gain from another tightening of monetary policy. Scarcity value is likely to be another boon for the 30-year issue, given that the maturity is now sold only twice a year.
Some market analysts expressed the view that the when-issued long bond could benefit from its 30 1/4-year maturity. The Treasury chose that maturity to give zero-coupon dealers more choices of bonds to strip and to further increase supply by possibly reopening the bonds when the Treasury sells 30-years again in February.
In the futures market, the September bond contract ended down 6/32 at 104.19.
In the cash markets, the 6 1/8% two-year note was quoted late yesterday unchanged at 99.26-99.27 to yield 6.20%. The 6 7/8% five-year note ended unchanged at 99.21-99.23 to yield 6.94%. The 7 1/4% 10-year note ended down 4/32 at 99.17-99.21 to yield 7.29%. The 6 1/4% 30-year bond ended down 9/32 at 84.16-84.20 to yield 7.56%.
The three-month Treasury bill ended down six basis points at 4.52%. The six-month bill closed down three basis points at 5.10%. The year bill ended unchanged at 5.57%.
The primary market for corporate securities virtually ground to a halt yesterday as issuers and investors wondered how this week's deluge of government supply would affect the broader fixed-income markets.
With intermediate- and long-dated Treasuries feeling the weight of new supply, corporate debt issuers kept their offerings on the shelves. Investors were also absent from the market as few were willing to risk taking positions in the market during the quarterly refunding and ahead of a possible Fed tightening next week.
In the secondary market for corporate securities yesterday, spreads of investment-grade issues widened by about 1/8 of a point, while high-yield bonds generally held steady.