Short-term US treasuries slip

Short-term US Treasury debt prices turned lower on Wednesday after an auction of two-year notes drew only modest demand, particularly from indirect bidders. While longer maturities proved more resilient, the sale of $24 billion in new two-year Treasury notes went at a high yield of 3.245 percent, disappointing traders and pressuring the short end. The notes drew bids for 2.01 times the amount on offer, only just beating the modest 2.00 achieved at the last sale and below last year's average of 2.2.
Primary dealers were saddled with the bulk of the issue, taking down $16.12 billion, while indirect bidders - including customers of primary dealers and foreign central banks - picked up just $6.86 billion, or 28.6 percent of the total.
That compared with an already modest 33 percent at the last sale and was the lowest since August 2003.
"In the absence of aggressive intervention moves from foreign central banks, particularly in Asia, we're likely to see this number come in low rather than high," said Alex Li, interest rate strategist at Credit Suisse First Boston.
Still, Li said a wholesale pullout by offshore central banks from the Treasury market was unlikely, given that the latest figures still showed decent, albeit reduced, Asian demand for US government debt. After the auction, yields on the current two-year note ticked up to 3.27 percent from 3.22 percent late Tuesday. The benchmark 10-year note stayed flat, leaving yields at 4.20 percent.
Traders attributed persistent strength in longer-dated maturities largely to a give-back for Tuesday's sell-off, which took its toll on the 30-year bond in particular.
The divergence between the short- and long-end helped fuel a renewed flattening of the yield curve, with spreads between 10- and two-year notes narrowing to 93 basis points.
Five-year notes dipped 2/32, yielding 3.73 percent, but the long bond was still up 11/32 for a yield of 4.67 percent.
There was no major economic news to affect bonds, with traders awaiting the release of fourth-quarter GDP on Friday.
As for the interest rate outlook, the market was still pricing in quarter percentage point rate hikes at the Fed's next three policy meetings, which would take the federal funds rate to 3.0 percent by the summer.
After that, opinions diverge, with the interest rate futures market predicting fed fund rates no higher than 3.75 percent by year-end, but some economists seeing a chance that official rates might reach 4.0 percent or more.
At the margins, investors were keeping an eye on the volatile oil markets, where prices were lower after a report showed an increase in US crude stockpiles.
Oil price fluctuations have not had a perceptible impact on bonds in recent weeks, but could do so if a sustained rise in costs is perceived as a possible harbinger of inflation.
"If oil prices break above $50, we would expect the two-year nominal area to rally, as the Fed is concerned that a renewed spike in oil could retard growth," said Richard Gilhooly, fixed-income strategist at BNP Paribas.