Treasurys Recover, But a New Note Auction Looms

Bonds moved off their highs ahead to the government's 7-year note auction this afternoon.

The 10-year was yielding about 3.71 precent, compared to an earlier level of 3.65 in late morning.


"We're down about a point from the high," said Michael Franzese, head of the Treasury desk at Standard Chartered. "I think people are not going to take a chance to get run over again, going into this auction," he said.

Yesterday's auction of $35 billion in 5-year notes went smoothly, but as soon as it was finished, a wave of selling hit the Treasury market, pushing yields sharply higher.

Traders said much of the selling was the result of mortgage-related hedging, where traders sell long-dated Treasurys as mortgage rates rise.

Both the 10-year and the 30-year were firmer, and the shorter end saw selling just after noon. The yield on the 10-year was as high as 3.73 percent after yesterday's auction.

"The tone of the market is a little better than yesterday. Mortgages are trading a little better, swap spreads are better and there's a little buying overall. I think you'll see a decent auction, but we saw a decent auction yesterday," said Rick Klingman, managing director of Treasury trading at BNP Paribas, earlier this morning.

"It's calmer. I wouldn't say things are fixed," said John Sprow, chief risk officer at Smith Breeden. "At least we're out of yesterday's panicked feeding frenzy. But it may come back this afternoon. Things are not so hunky dory."

The Treasury's 1 p.m. auction today is for $26 billion in notes.

"The big wave of convexity (mortgage-related) selling has for now abated," Sprow said.

The Fed, as part of its quantitative easing project, has been buying mortgages to keep rates low. It also has been an active buyer in Treasurys.

Some traders have been critical of its efforts, saying it may need to increase its fire power as well as target different sectors of the Treasury curve.

"The big buyer of mortgages is the government itself," Sprow said. "Mortgage rates are quite a bit higher than they were - 40 to 50 basis points. The question is are they trying to target a specific rate or just keep things relatively well working. They are probably not at a level yet which is causing them fright, where people can't refinance."

As mortgage rates for 30-year fixed mortgages have climbed back above 5 percent, mortgage applications, including refinancings, have dropped.

The Mortgage Bankers Association said Wednesday that for the week of May 22 its survey showed mortgage application loan volume fell 14.2 percnet, and the refinance index fell 18.9 percent, from the previous week.

30-year mortgages are often correlated to the 10-year Treasury.

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