As Bond Sales Resume, Will Investors Finally Say 'Enough'?

The first auction of this week's busy Treasury sale provided some indication that investors' appetite for government debt is not yet completely full.

Investors scooped up $10 billion in Treasury Inflation Protected Securities, accepting a yield lower than analysts had estimated in an apparent sign both of growth fears and belief that Treasurys are still a worthwhile safe haven.

In a further effort to underwrite trillions of dollars in stimulus and bank bailouts, the government this year is expected to issue $2.4 trillion in debt, beginning with this week's $84 billion in auctions.

Investors fled Treasurys through much of December but then turned out in decent numbers for a late-month offering of longer-dated bills, results that surprised analysts who thought inflation fears would keep buyers away from the far end of the yield curve.

With the Federal Reserve's policy firmly in place to keep interest rates low until the economy recovers, investors seem unafraid for now to buy Treasurys no matter the duration. The trend in this week's subsequent auctions will tell much about the direction of monetary policy and borrowing rates, and the principal question will be how much will the government have to pay investors to get on board.

"There was probably late in 2009 a rush to put on some Treasury positions and things like that to hold the highest quality for your balance sheet," said Mike Larson, an analyst with Weiss Research. "Now you're going to see a much truer picture of demand and how that compares to the supply that you're going to see on the market."

The first round of auctions—Monday's $10 billion sale of 10-year Treasury Inflation Protected Securities—went smoothly, with the 1.43 percent high yield about half a percentage point below Wall Street estimates.

To be sure, TIPS, which are tied to the Consumer Price Index, are distinct from Treasury notes and long bonds.

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But the reception was indicative that fears have been held mostly in check over whether investors eventually will tire of the constant conveyor belt of government debt.

"It doesn't look like there's a big problem. The markets aren't showing a lot of worry," said Kim Rupert, managing director of global fixed income analysis at Action Economics in San Francisco. "They might not be stellar but I don't think these are going to be the auctions that fail."

The notion that Fed policy will remain accommodative to growth and undaunted by inflation prospects only gained ground after Friday's unemployment report showed the economy shed an unexpectedly high 85,000 jobs in December.

Larson had warned of a bond bubble well before last year's awful Treasury returns. But he also said the day likely hasn't come yet when investors launch a wholesale strike against long-dated debt.

While today's $10 billion auction of Treasury Inflation Protected Securities went well, results are less certain for the three-, 10- and 30-year sales to come as the week progresses, Larson said.

TIPS gained about 10 percent in 2009 while Treasurys fell 3.5 percent.

"People are looking for protection from inflation in this market and it's easy to see why," he said. "The jobs report wasn't awful enough to put the double-dip (recession scenario) back on the table, but it wasn't good enough to prompt some action from the Fed."

Nevertheless, he sees yields eventually having to rise to reward investors willing to take on long-term bonds, which are most sensitive to inflation.

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"When it comes to the auctions later in the week you're going to continue to see protection there," Larson said. "The market's going to have to build in a concession to get investors to step in and buy long-term debt."

Analysts will be watching the Treasury auctions closely for clues about the trend in rates.

Mortgage rates have begun drifting higher amid concern that long-term borrowing rates could rise regardless of what the Fed does with its key interest rate. A push higher on Treasury yields would accomplish that, as might an interest from policy makers to compress credit spreads and encourage banks to take risks and start lending again.

"The trend in rates is higher. It's going to be a question of the upward push," Rupert said. "I'm thinking it's going to be more gradual, but at some point, be it from a Fed comment or some piece of data, the acceleration could be pretty quick."