A funny thing happened on the way to the 5-Year Treasury auction today. Nobody showed up. This afternoon, the Treasury auctioned off $35 billion of 5-year notes. The bid-to-cover ratio came in at 2.6 — a level so low that it hasn’t been seen in the past 12 months. The pundits put forth two theories as to why the auction came off so poorly: 1) Growing comfort about tomorrow’s Greek austerity vote ended the flight to quality of the UST, and/or 2) The lack of the Federal Reserve as a major purchaser of Treasury Notes is showing the weakness in “real” underlying demand.
Anybody claiming to be comfortable with the Greek austerity vote must not own a TV. The peasants are revolting. In a big way. Anarchists were in the streets of Athens carrying hammers, with which they could chip off pieces of the curbs to hurl at police. Molotov cocktails were being tossed. Now I’m no expert in the social sciences, but my first reaction to these developments is not to rush out and crank up the “risk-on” trade.
As for the idea that the Fed, having left the building, leaving a demand void… Perhaps that is somewhat overstated. I think that is a factor, but what is more believable to me is simply that the short end of the yield curve is struggling to find its level in the new world of smaller bid-to-cover ratios.
Now, let’s return to the 2-day graph of 5-year Treasury note yields. Yields worked higher yesterday, rising from 1.376% to 1.450%. That’s a 4.86% increase in the underlying rate. Nothing to sneeze at. After today’s weak auction, the 5-year rate moved to 1.588% — an increase of 9.51%. That’s pretty severe.
In context, however, the absolute rate still remains well below the 2.4% level reached in February. There are two things we think worth watching: 1) the speed with which rates move upward if this trend continues, and 2) whether these moves will begin to affect the longer end of the yield curve. We have been expecting a shift upward on the entire curve and will be watching the longer maturities with caution.
I’d like to hear your thoughts, so feel free to leave a comment.