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Treasuries in Trouble?Dave Forest This was a big week for the bond market. The U.S. auctioned over $100 billion in 2, 5 and 7-year notes. As we've discussed over the last several weeks, these bond auctions are critical for the U.S. in financing its deficit spending. The U.S. government has already run up a $1 trillion budget deficit this fiscal year. They need money coming "into the till" to keep up this spending. And a lot of it. Because of America's massive financing needs, observers have been keeping a close eye on the results of these bond auctions. The main question is: will investors keep stepping up to the plate to buy Treasuries when they know the U.S. is planning to issue new bonds by the fistful over the coming months and years? Or will buyers starting putting their money elsewhere, leaving the U.S. in the lurch? There are a few ways of gauging how much interest investors have in U.S. bonds. One of the most-followed is the "high yield" of a bond auction. Basically, the yield is the effective interest rate that bond buyers demand in exchange for lending their money to the U.S. government. The high yield is the highest interest rate that the government was forced to pay at a given auction in order to secure all of the buying that it needs. A quick example. Suppose the government wants to sell $10 billion in 5-year notes. Buyers submit their bids detailing what yields they are seeking. In this case, one bidder is willing to buy $5 billion in notes at a yield of 2%. Another buyer wants $2.5 billion in notes, but demands a yield of 2.1%. The final buyer bids $2.5 billion at a 2.2% yield. If the government wants to sell the entire $10 billion in notes, they are going to pay 2% on $5 billion, 2.1% on $2.5 billion, and 2.2% on $2.5 billion. The "high yield" is the highest rate the government pays in order to close the auction. In this case, 2.2%. If demand for bonds is strong, investors will accept lower yields. This was the case last October. With the financial world in chaos, many investors simply wanted a safe place to park their money. With U.S. Treasuries seen as one of the safest investments on the planet, there was a lot of competition to buy these bonds and notes. Investors couldn't ask for high yields or they would simply get underbid by other buyers and end up getting nothing. They had to settle for low yields. But if demand for bonds decreases, buyers have less competition. And more freedom to ask for higher yields. The high yield of a bond auction is thus seen as being an indicator of how much interest investors have in U.S. bonds. It is the payment that the pickiest bidders are demanding in return for their money. And rising yields have been giving the U.S. some cause for concern lately. Throughout 2009, yields on longer-dated notes have been going up. Since February, high yields on the benchmark 30-year bond have risen from 3.54% to 4.72%. A 33% increase in financing costs for the U.S. government. Yields on shorter-dated notes are up even more, percentage-wise. In the same period, the high yield on the 7-year note rose from 2.39% to 3.33%. Up 40%. The 5-year note yield had the largest jump, up 50% from 1.82% to 2.70%. The pattern of rising yields continued at this week's auctions. Most concerning was the fact that high yields on the 2-year and 3-year notes rose significantly for the first time since last October. The 2-year note yield had held between 0.92 and 0.95% since last December. This week it jumped to 1.15%. The 3-year note has been between 1.2 and 1.5% over the last six months. This week it was up 33% to 1.96%. Do these rising yields mean that investors are losing their appetite for U.S. bonds? Is America in danger of a "failed" bond auction like we've seen in the U.K. and Germany, where the government can't sell its bonds at an acceptable rate? The short answer is no. True, bond yields are rising. Investors are asking for a higher rate of return in exchange for lending their money to the U.S. But another, less-followed statistics shows that interest in American bonds is still high. That's the bid-to-cover ratio. This is a simple statistic: the ratio of total bids at an auction to the amount the government is seeking to place. For example, suppose the government wants to auction $10 billion in notes. And they receive $20 billion in bids from investors. The bid-to-cover ratio for this auction is 2. Indicating that investors were interested in 200% more bonds than the government was seeking to sell. Obviously, a higher bid-to-cover indicates a greater level of investor interest. And even though bond yields have been rising over the last few U.S. auctions, bidto-cover ratios have remained steady. In fact, the bid-to-cover ratios for this week's 2, 5 and 7-year auctions were the highest this year. For all three categories of bonds, bid-to-covers have risen by 25 to 30% since the beginning of the year. As yields are getting more attractive, more and more investors are lining up to buy bonds. This shows that buyers are still out there, at the right price. Of course, higher yields mean the U.S. will have to pay more to service its debt. But the rising bid-to-covers indicate that fears over the death of U.S. bond sales are greatly exaggerated. For the time being. Jun 27, 2009 Copyright ©2009-2010 Resource Publishers Inc. Note: To subscribe to Pierce Points please click here: www.piercepoints.com Pierce Points
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