Treasury Auctions And Fed Speak Give First Hint Of The Post-QE Bond Market

With this week's note auctions coming on the heels of so many statements by

Board Members, the market is showing investors what the bond landscape will look like once the Fed begins to tighten next year.

The results so far suggest that the very short end and the long end of the yield curve will continue to attract strong demand.

The belly of the curve, two, five, and seven year notes, will come under the most pressure as market participants gauge when and how fast the Fed will return to “normalization of policy” as laid out by Fed Chair Janet Yellen at last week's news conference.

A recent poll of economists is calling for the Fed to raise its Fed Funds rate next July. This week's auctions confirm the bond market will attempt to “get ahead” by pushing up yields.

Two-Year Notes

On Tuesday, the Treasury's $29 billion sale of two-year notes attracted the strongest demand from foreign buyers in almost three years. Higher short term yields in the U.S. versus other large economies, and a strengthening dollar, are attracting capital.

The securities priced at a yield of 0.589 percent, the most since April 2011. Indirect bidders, which include foreign central banks, purchased 40.9 percent of Tuesday's issuance. This matched the most since November 2011.

Five-Year Notes

Wednesday's five-year auction saw weak demand. The securities priced at a yield of 1.8 percent.

The Fed's 22 Primary Dealers took down 41 percent of the notes. Direct bidders, non-primary-dealer investors, who place their bids directly with the Treasury, bought only 8.8 percent of the notes, the lowest in 14 months. Overall, the bid-to-cover ratio, was 2.56, the lowest since December.

One-Month T-Bills

Demand from banks and money-funds has pushed short term T-bill rates lower this week. Financial institutions tend to add reserve capital, called “window dressing”, at quarters'-end. This has helped push the one-month T-bill rate below 0.00 percent, but it is expected rise above that level after quarter end.

The long end of the Treasury bond market is supported by the strong dollar and foreign demand. The short-end of the bond market remains the preferred fixed income investment of those seeking preservation of capital and safe haven investing.

Fed Speak

The “Fed Speak” earlier in the week has been both dovish and hawkish. The Fed's William Dudley cautioned for patience before raising rates. Fed speakers James Bullard and Esther George took the opposite approach, arguing for the removal of the term “considerable period” from next month's Federal Open Market Committee statement and the beginning of tightening in the immediate future.

Economic Data

Economic data has been mixed this week.

New home sales

jumped 18 percent in August to an annual rate of 504,000, the strongest report since May 2008, but existing home sales disappointed.

The strong new home sales report carries more significance than September 22's poor existing home sales's report because new home sales lead directly into increased construction employment. Existing home sales has no direct correlation to jobs growth.

Mortgage applications fell 4.1 percent percent last week and have trended lower for much of 2014. This suggests that all-cash deals on the high and low end dominated the new home market this year. Possibly affecting the housing market, the Fed will end its buying of mortgage-backed securities next month.

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