US Treasuries prices fell on Thursday, despite solid demand at a 30-year bond auction after Moody's Investors Service placed the United States' top-notch credit rating on review. Vigorous bidding for this week's entire $66 billion worth of government debt supply was expected to rekindle a bond market rally that had sent benchmark yields to their lowest more than seven months on Tuesday.
Instead the afternoon market sell-off left traders and analysts scratching heads, looking for answers. "We were surprised by the resilience of the market going into this week's supply. It's quite ironic that we ended up lower after a strong auction," said Rich Bryant, head of Treasury trading at MF Global in New York.
Traders and analysts blamed the day's perplexing market action on a combination of factors. Those included Federal Reserve Chairman Ben Bernanke's remarks that the US central bank is "not prepared at this point" to take action on more stimulus, competition from a $1.75 billion 30-year bond deal from J.P. Morgan, and a news report Washington has reached a budget deal but the size of cuts was smaller-than-expected.
Shortly after the 30-year auction that briefly helped pare losses, Dow Jones Newswires reported the White House and Congressional leaders could agree to about $1.5 trillion in deficit cuts and might be able to agree to an additional $200 billion in cuts. "The market is telling you that the cuts are not deep enough," said Mark Pawlak, market strategist with Keefe, Bruyette & Woods in New York.
US President Barack Obama has proposed long-term budget reduction as much as $4 trillion, while Republican leaders have been pushing for steep spending cuts without raising taxes or removing subsidies and loopholes. Smaller-than-expected budget cuts mean the government would still rely heavily on borrowing and issuing debt to fund its budget gap, a factor that would continue to threaten its top-notch ratings with the major ratings agencies.
Even if a default is averted with a debt ceiling increase by August 2, Moody's said on Wednesday it might change its outlook on the world's largest economy to negative unless there is a "substantial and credible" plan on long-term deficit reduction. Such a less severe rating move could still raise the borrowing cost for the US government. Uncertainties over the US fiscal predicament overshadowed concerns over Europe's debt crisis and a slump on Wall Street, analysts and traders said.
Benchmark 10-year Treasury notes ended down 19/32 in price to yield 2.92 percent, up from 2.88 percent on Wednesday afternoon just before Moody's announced the US ratings review, according to data from Tradeweb. The 30-year bond finished down 1-12/32 in price for a yield of 4.26 percent, up 8 basis points from late Wednesday.
In the credit default swap market, the cost of buying insurance against a US default rose to its highest level in almost one-and-a-half years on Thursday, jumping 4 basis points to 56 basis points, or $56,000 per year to insure $10 million for five years, according to Markit. Though the contracts still reflect a very low probability that the US will skip a debt payment, the jump in price nonetheless reflects increasing concern that lawmakers will fail to rise the debt ceiling before an August 2 deadline.
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