BOND REPORT: Treasurys Pare Losses After Strong 2-year Auction

By Deborah Levine

Treasurys pared losses Tuesday, pushing up yields, after the government's auction of $40 billion of two-year notes met strong demand.

Two-year note yields (UST2YR) rose 1 basis point to 0.92%, compared to 0.93% before the action. Bond yields move inversely to prices.

The Treasury awarded $40 billion in 2-year securities -- an amount that matches a record high set last month -- at 0.949%.

Traders and investors often sell existing holdings in order to buy the more liquid, newest securities. At the past four auctions of 2-year notes, bidders offered, on average, $2.39 for every dollar available.

The indirect bid, a carefully watched category that includes foreign buyers, was 53.1%, which was "the highest since the 56.0% on November 2006," said bond strategists at Action Economics. "This offering was a no-brainer for traders given the cheapening of the issue and with the Fed putting skin in the game."

The bid-to-cover -- which measures bids received to bids tendered -- improved to 2.71 from 2.63 in last month's auction.

"The only problem with today is that the Treasury will have to do it all over again tomorrow and again on Thursday, selling $34 billion of 5-year notes and $24 billion of 7-year notes," said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. "With a deficit of nearly $2 trillion, the pressure to attract buyers will remain high for quite some time."

The government will also sell a record $34 billion in 5-year notes (UST5YR) on Wednesday. On Thursday, it will auction $24 billion in 7-year notes, only the second sale of the maturity in more than a decade. Both amounts are $2 billion more than at the last sale.

"The prospect of three large Treasury auctions puts us in the inevitable 'let supply wreak its havoc' mode," said strategists at RBS Greenwich Capital.

These will be the first auctions since the Federal Reserve last week said it would buy up to $300 billion in Treasury securities over the next six months.

Its purchases are expected to be made from the market, not directly at the auction, but analysts note the central bank is likely to be most interested in the newest issues, since they serve as benchmarks for rates on other forms of debt, including corporate, mortgage and consumer lending.

Doing that would also relieve pressure on the government's 16 primary dealers, which have to bid at auctions of ever-increasing amounts of debt, to finance all of the economic programs to fix financial markets.

"An informal Fed backstop for the auction process would remove some of the underwriting risk for dealers and might result in lower market yields," said analysts at Wrightson ICAP, a research firm specializing in government finance. "Unfortunately, the Fed may not be ready to commit itself to a specific framework for Treasury purchases as early as today."

Last Wednesday, the Fed said in a statement it would begin purchases late in the week.

Also on Tuesday, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner pressed Congress to give them new powers to close down non-bank financial firms in an orderly fashion.

They noted that they had to improvise to bail out American International Group (AIG), because of all of the exposures of banks, state and local governments, and money-market funds to the insurance giant.

Benchmark 10-year yields (UST10Y) were up 7 basis points, or 0.07%, to 2.72%.