NEW YORK (Reuters) - In the first auctions the Treasury Department will hold since the Federal Reserve unveiled a new program to sell short-dated paper and buy longer notes and bonds, the question may be: How low can yields go?
The Fed announced on Wednesday it would sell Treasury notes with maturities of three years or less and use the money to buy debt with maturities of between seven and 30 years. The program will be worth $400 billion and is expected to absorb most of the supply of new 30-year bonds from the market over the coming months.
Some analysts think that could put a new spin on the Treasury’s issuance of $99 billion in new debt on Tuesday, Wednesday and Thursday, since two-year yields have the potential to inch up during the Fed sales.
But others say the Fed’s previous pledge to keep interest rates unchanged until at least the middle of 2013, and historic lows reached this week in Treasury yields, are likely to remain the key defining factors of the auctions.
The Treasury will sell $35 billion each of two-year and five-year notes on Tuesday and Wednesday, respectively, followed by $29 billion in seven-year notes on Thursday.
“I think the twos and fives, and sevens, the Fed’s about to start a buying program, I would say they get taken down without very much of a concession, but I’m not saying whether or not they tail or stop short,” said Suvrat Prakash, interest-rate strategist at BNP Paribas in New York.
Stopping short means the high yield at an auction is lower than the simultaneous open-market yield. Tailing means it is higher.
Prakash said the Fed’s zero interest-rate policy would keep the bid solid for twos and fives, while sevens would directly benefit from the Fed’s $400 billion program, dubbed Operation Twist.
“It seems like it’s just a win-win scenario for the Treasury market at this point. That’s why we’re at these crazy low yields,” he said.
Michael Cloherty, head of interest-rate strategy at RBC Capital markets, said the two-year auction would be, for the first time in many months, at least not a sure stop-through. But he added that the Fed’s interest rate policy could keep any variations in the two-year auction performance in check.
“Usually it’s your longest maturity auctions which are the riskiest,” he said. “This time it’s going to be flipped around. You do get help from zero interest rate policy. You do get help from flight to quality out of equities.”
The auction outcomes may also depend heavily on developments in Europe, where a financial crisis triggered by a collapse in confidence in several countries’ sovereign debt continues to rage.
European policymakers showed signs they were preparing new steps to cope with the region’s debt crisis even as talk of a possible Greek default gained pace on Friday.
“We’ll be waiting to see if anything happens over the weekend in Europe. If there’s no new news, I would expect Treasuries to rally a little bit,” Cloherty said.
Editing by Padraic Cassidy