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By Eric Burroughs
NEW YORK, Dec 27 (Reuters) - U.S. Treasuries rose at midmorning on Thursday
despite a record-sized auction of two-year notes looming later in the session,
as the market received a technical boost in very thin trade.
Treasuries had slipped in early trade, suffering a fourth day of declines ahead of the Treasury Department's $23 billion auction of new two-year notes, a record amount and an increase of $2 billion from what was a poorly received auction in November. New debt supply typically depresses prices.
After the futures contract on the 10-year note held key support and moved higher, Treasuries across the board rose despite another day of gains in Wall Street stocks. But traders shrugged off the move as just noise in a very quiet session.
Traders have worried the market may have a hard time digesting the new notes with few desks active in the market and investors now positioning for an economic recovery. Short-term Treasury notes suffer on expectations for economic growth and the potential for future Federal Reserve interest rate hikes.
As a result, in pre-auction trading the new two-year note has traded about 10 basis points higher in yield than the current issue at around 3.30 percent as dealers try to make the paper more alluring to investors.
Yields on current two-year notes currently stand at 3.20 percent, nearly 1.5 percentage points higher than the current federal funds rate of 1.75 percent, signaling that the market has already positioned itself for an eventual switch in Fed policy, analysts said.
Those high yields could prove a boon to investors if upcoming economic reports fail to ratify growing expectations that the economy, mired in its first recession in a decade, is gaining strength to rebound solidly in the first half of 2002.
``As big as it may be, the two-year note is fairly cheap to where the funds rate has built in the risk the Fed's going to reverse course. I don't see it as too big of a risk for the market,'' said Josh Stiles, senior bond strategist at IDEAglobal.
The auction will take place at 1 p.m. (1800 GMT) and the results will be announced shortly afterward. Once the market gets past the auction hurdle, short-term notes will likely recover some of their lost ground from recent sessions, traders said.
Since June, the Treasury has more than doubled the amount of two-year notes it issues each month as fiscal surpluses have quickly turned to deficits after this year's $1.3 trillion tax cut and the spending boosts following the Sept. 11 attacks. The Treasury is concentrating new debt issuance in short-term maturities.
Bond investors are waiting for a big batch of economic data on Friday to get a better sense of whether the economy has already hit bottom and is staging a recovery. Friday's reports include November durable goods orders, weekly jobless claims, November home sales and December consumer confidence.
For now bond investors see a slim chance for a 12th Fed interest rate cut at the central bank's late January meeting, but investors are waiting for major economic reports on manufacturing and employment due out the first week of January before placing any big bets.
Since early November, Treasuries prices have plunged and yields have streaked higher as signs of an economic recovery, year-end profit-taking and a growing belief the Fed is done cutting interest rates halted an 18-month bull market. The aggressive sell-off has been compared to some of the bond market's most abrupt reversals in the past decade.
At 10:30 a.m. EST (1530 GMT), two-year Treasury notes Benchmark 10-year notes
Related News Categories: currency, US Market
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Benchmark 10-year notes