UPDATE 1-Canada 2-yr bond auction sees softer demand

Wed Oct 19, 2011 2:31pm EDT

Related Topics

* Softer but solid demand for save-haven gov't bonds

* Yield rises to avg 1.097 pct from 0.954 in Sept

* Bid-to-cover ratio dips to 2.38 from 2.53

By Andrea Hopkins

TORONTO, Oct 19 (Reuters) - Canada's sale of two-year government bonds met with softer but still healthy demand on Wednesday as ample supply kept buyers in check and progress on the European debt crisis boosted risk appetite.

The C$3.5 billion ($3.47 billion) auction of bonds produced an average yield of 1.097 percent, up from 0.954 percent at the last two-year bond auction in August, in line with market rates and back above the Bank of Canada's overnight interest rate target of 1 percent.

But even with the higher yield, the bid-to-cover ratio in the auction edged down to 2.38 percent, below the 2-year bond auction average of about 2.57 percent, according to Ian Pollick, a fixed-income strategist at RBC Capital Markets.

"On the surface it looks like it has some softer demand but given the fact that it came in on the screws to where it was trading on the screens, it was pretty positive," Pollick said.

"We know it is a hard value proposition to tell people to get long on the front end, especially when you have all this optimism floating around. But at the end of the day it did on balance feel like a very reasonably good auction, better than we had thought."

The auction came amid a new round of optimism that European leaders will make progress on the euro zone debt crisis this weekend, sentiment that has boosted risk appetite among investors and cut bond prices.

Sunday's EU summit is considered a make-or-break meeting on beefing up the euro zone's bailout fund, the European Financial Stability Facility, and resolving the Greek debt crisis, which threatens to engulf the entire euro zone.

Concerns about the crisis and slowing global growth have kept pressure on the Bank of Canada to leave official borrowing costs low for longer, and some economists have pushed out expectations for the next bank rate hike to 2013.

That has left two-year government bond yield stuck in a tight trading range between a multi-decade low of 75.7 basis points and 112.7 basis points for the last two months, making Wednesday's auction a good buy in the eyes of investors skeptical a European solution is around the corner.

"We've had a good concession in the front-end of the curve, so ... this probably seemed a bargain for more pessimistic people," Pollick said.

He also noted there is a lot of supply coming down the pipeline for the two-year bond, with two more auctions before the end of the quarter, making it unlikely that yields will richen up relative to the current two-year benchmark.

There were more than C$8.34 billion in bids from Canadian primary dealers at the auction. The bid-to-cover ratio of 2.38 was down from the 2.53 percent of the previous auction.

The ratio is a gauge of investor appetite, and a reading above 2 generally implies a well-received auction.

The bonds, which carry a coupon of 1 percent, will be issued on Oct. 21. The outstanding debt of the issue after the auction is C$3.5 billion.

Details on Bank of Canada webpage:

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