With the 30-year bond auction out of the way, traders are looking ahead to the possibility the Fed pulls the trigger on a new bond market operation at its meeting next week.
Anxiety was running high ahead of Thursday's auction, driving the price of the 30-year down as much as a point in morning trading. The auction, however, was well bid, drawing $37.07 billion in bids for $13 billion in reopened 30-year bonds, at a high rate of 3.31 percent.
After the auction, the 30-year yield touched its low of the day, 3.269 percent. The long bond went from being the worst performer on the curve to the best, as the end of the auction drew out buyers.
"It was a very good auction, much stronger than most people anticipated. Decent direct and indirect bidding. Nice follow through," said Rick Klingman, who heads BNP Paribas Treasury trading.
The 30-year has been the beneficiary recently of speculation that the Fed will be a buyer of the bond if it embarks on a new easing program to extend the duration of its portfolio, a program Wall Street calls "Operation Twist." The yield, therefore, has been moving lower, in an inverse direction to prices.
Traders say developments in Europe trump Fed chatter, but the Fed is high on their list. "The next big thing is the Fed meeting, and whether they do 'operation twist' or not," said Klingman.
He said the market may be betting wrong, though, when it comes to the 30-year. He said the Fed may choose to buy 7-year and 10-year notes to placate the FOMC's hawkish members, if it decides to go ahead with the program.
"It affects mortgages more, helps the housing market more. The unwind becomes tougher down the road" with the 30-year, said Klingman.
"The 'operation twist' is a possibility. I just worry that these policies go to what end? You're not going to increase employment by lowering interest rates any more," said Brian Edmonds, head of interest rate trading at Cantor, Fitzgerald.
Edmonds said beyond Europe and the Fed, he is watching the action in commodities and currency markets.
Indirect bidders, which could include central banks, took 39.4 percent, while direct bidders received 17 percent.
"The street was a little complacent, thinking there wouldn't be great demand for bonds," said Edmonds "Clearly, there was much better demand for the back end of the curve. You have to think some major players needed bonds."
Prior to the auction, the long bond was as much as a full point lower ahead, ignoring weak retail sales data that boosted bond prices further down the yield curve.
"I was a little worried about how wide 10s and 30s have been...That's one part of the curve that has been historically steep," said Edmonds.
The spread between the 30- and 10-year was 130 bps Wednesday. At the end of 2008, the last time the 10-year was at this level, the spread was at 55 bps.
Retail sales for August came in unchanged from July, below expectations for a 0.3 percent gain.
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