Weak 5-Year Auction Puts Spotlight on 7-Year Auction

The government's weak 5-year auction initially dampened some buying activity in Treasurys and put the spotlight on Thursday's auction of $30 billion in 7-year notes.

Ahead of Wednesday's auction, Treasurys were moving higher on surprisingly poor housing data, rumors of more European debt downgrades and a Fed meeting on the near horizon.

"Take your pick. It's certainly a little bit of everything," said David Ader, chief Treasury strategist at CRT Capital. The 1pm ET auction was just before the Fed's release of its 2:15pm post-meeting statement, which talked about weaker financial conditions due to the problems overseas.

"Rates were doing very well this morning. The auction tailed. It was a very weak auction. Real buyers pulled away at the auction, but it may only mean they were buying before hand. Volume has been very good," he said.

The auction of $38 billion in 5-year notes stopped out at 1.995 percent, above the 1.959 percent level right before the sale. After the Fed statement, buyers pushed 5-year yields lower to 1.912 percent.

The bid-to-cover ratio was 2.58, below a six auction average of 2.69. Indirect buyers, a group which could include foreign central banks, made up 24.6 percent of the buyers, down from an average 44.4 percent. Direct bidders were at 10.7 percent, down from 12.2 percent, and as a result, dealers took away 54.8 percent of the auction, compared to a 43.4 percent average.

"It was surprising, to be honest, after how well yesterday's two-year auction went," said Rick Klingman of BNP Paribas.

"Given the technical condition of the market, given the way we broke out to the upside, the overall tone of the market, I was expecting a much tighter auction and more customer participation than we got. It was weak across the board."

"If you made me come up with a theory, I'd say people saw what happened to 2-years yesterday and said we don't want to pay through the market," Klingman said.

Treasurys were benefiting form a flight to safety bid, as yields widened on Greek and other European issue. "I think some money that was sitting on the sidelines waiting for better yield levels was forced into the market," Klingman said of the morning's action.

He said, however, that the auction of $30 billion in 7-year notes Thursday may do better. "That's anybody's guess. ...We had one very very strong auction and one very very weak auction. People tend to use the 7-year note to take care of some of the buying needs they have."

Ader said the market has broken its old range over the past couple of days, and the new range for 5-year yields could be mid 1.80s to up to 2.04/2.05 percent.

"10-years could readily test 3 percent and on he upper end 3.25/3.26 looks like a good hold," he said.

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