New U.S. debt issuance -- hot or not?

NEW YORK Mon Jul 25, 2011 12:54pm EDT

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NEW YORK (Reuters) - Get them while they're hot. Or not.

Investors will have their last chance this week to buy U.S. Treasuries directly from the government before the August 2 deadline for raising the U.S. debt ceiling and staving off a possible credit default.

The Treasury will auction a total of $99 billion of two-, five- and seven-year notes on Tuesday, Wednesday and Thursday, respectively.

While most investors believe Republicans and Democrats will reach a last-minute deal that eliminates the potential for a U.S. default, the idea of buying an IOU from an entity that might soon miss payments on its loans is a strange one for investors.

Whether buyers will step up "is so hard to say because we have never really been here before -- most of us don't really believe that they are going to allow the debt to default," said David Coard, head of fixed-income sales and trading at The Williams Capital Group in New York.

He notes the three auctions all settle on August 1, a day ahead of the deadline laid out by Treasury Secretary Timothy Geithner for the United States to run out of money to pay its debt if the $14.3 trillion debt ceiling is not extended.

"In the absence of a new agreement, I don't think there would be any question about this debt because it does settle before August 2," Coard said.

Expectations the government will stave off a default had most investors thinking this week's auctions won't be a total disaster. But with Treasury note yields holding not far off their lowest levels this year, buyers will likely be looking to shave an edge off prices.

"In general, there's still good demand for Treasuries but I do think that as the week progresses, traders could become increasingly uncomfortable with the level of uncertainty in the market, which could lead to more of a concession before the auction or at least some volatility around the time of the auctions," said Rich Bryant, senior vice president of U.S. Treasury trading at MF Global Securities in New York.

"I think in general the market's pretty comfortable with the front end and where yields are. If there wasn't demand, yields wouldn't be where they are," Bryant said.

The looming debt ceiling deadline increases the risk of reduced demand in the auctions and the potential they could "tail," or have high yields above where the market expects them, said John Briggs, Treasury strategist at RBS Securities in Stamford, Connecticut.

"Prudent risk management might cause some investors to bid less than they would otherwise, or not at all," Briggs said, adding "the base case is that the auctions come okay, but there is certainly a greater risk that you have larger tails in this week's auctions than you might normally otherwise have."

"Certainly the auctions are vulnerable."

If Tuesday's auction of $35 billion of two-year notes sees disappointing demand, that could set the tone for the other two, Briggs said.

"If tomorrow's two-year auction does not go well, then the (Treasuries) market is going to be vulnerable to selling going into the other ones," he said.

Technical factors might also contribute to a damping of demand in this week's sales, said David Ader, head of government bond strategy at CRT Capital Group in Stamford, Connecticut.

"Will it prove hard to buy twos, fives or sevens with this as a backdrop? We think so," Ader said. "Positions don't really reflect a great duration need, though the week does conclude with a moderate index extension that might encourage some duration buying," he said.

(Additional reporting by Emily Flitter; Editing by James Dalgleish)

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