Week's Bond Auctions Show Lingering Need for Safety

A belief that economic tumult has not completely passed and that the Federal Reserve is unlikely to make any dramatic rate moves has unexpectedly driven investors into Treasury auctions this week, bond experts say.

Treasury Building

Sales this week of 2-, 5- and 7-year US Treasury notes fetched higher demand than many analysts anticipated. The latter two notes were especially well received, despite a persistent belief that longer-dated debt will not be attractive in the coming year.

For those in the market, the auctions reflected caution among investors that safety is still a good bet. People are still worried that more fiascos such as this year's debt standstill at Dubai World lie beyond the horizon. Events such as the Christmas Eve terror attempt in Detroit could disrupt things as well.

"Dubai is a lesson, though we thought it was overhyped," said Kevin Ferry, president of Cronus Futures Management in Chicago. "It's a lesson that a lot of things in the world can go wrong and cause people to fall into Treasurys."

Conversely, the willingness to take on US debt marked a vote of confidence that the government is not in danger of failing or being unable to raise money to pay for its economic programs, Ferry added.

"If this stuff is priced at the right level, the government will still be able to fund itself," he said. "All other things being equal at the start of 2010, the auction process we witnessed this week is not about the failure of the American government, it's not about the failure of the Treasury. The idea is this is more normal."

Investors also likely were attracted by sheer value in Treasurys.

Bond prices have been falling precipitously throughout December, with the yield, which moves opposite price, climbing about 14 percent. That presents potential value to investors who see a future for government debt.

"You had the cheapening up leading to the auctions. It was enough to get some interest going again," said Bill Walsh, president of Hennion & Walsh in Parsipanny, N.J. "You still have a safety play in there. People are convinced that it's not going to be smooth sailing from this point on into 2010."

Analysts recently have been voicing concern about looming inflation, but more particularly about how the government would convince investors to buy Treasurys with the dollar yields staying so low.

Yet foreign demand, as measured through the indirect bid—or those who choose not to buy straight from the Treasury—remained strong through the week's auctions.

This comes even as the government has auctioned off $2.1 trillion in debt this year and Treasurys have offered historically low returns—a 3.4 percent loss for the year. And the supply-demand dynamic is unlikely to change much in 2010, when the government offers up another $2.4 trillion in notes.

Investors in 2010 will need to keep a watch on a number of metrics to determine value, and it's not just about the near-zero Fed funds rate that many investors watch, Ferry said.

Rather, investors should watch credit spreads and how ably the Fed negotiates the need to support currency while not restricting growth.

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"The key to being successful in 2010 is knowing the difference between strategy and tactics," he said. "Everybody knows how to trade a panic. How well can you do when there isn't one?"

Making that work on an individual basis will be all about determining risk tolerance and deciding whether better areas of safety can be found outside government issuance, or if Treasurys will be the best shelter from any storms remaining on the horizon.

"For an individual investor to go out and buy...the 30-year Treasury bond at 4 3/8 or 4.65, I don't think it's a good investment for them," Walsh said. "There are other alternatives that could prove to be more valuable for them, depending on what their goals and objectives are."