Long bond in worst sell-off since 1994

The US Treasury bond market suffered its worst long bond auction in 2-1/2 years on Thursday as foreign investors shunned it in the wake of a damaging budget battle and downgrade to the credit standing of the United States. Losses in the open market put long bonds on track for the worst drop since 1994 after the sale, which was the first 30-year bond offering since Standard & Poor's stripped the United States of its AAA credit rating on Friday.
The offering took a hit from extreme financial market volatility due to worries about the stability of French banks and a slowing US economy. This made Treasuries expensive despite S&P's downgrade and contributed to the poor bidding. Also, the Federal Reserve's decision earlier this week to keep short-term rates near zero for two more years may have disrupted bond pricing across different maturities. All these sources of uncertainty kept investors at home.
"Horrible auction," said William O'Donnell, head of interest-rate strategy at RBS Securities in Stamford, Connecticut. "It may be a while before the markets get 30-years priced on the curve appropriate to the Fed's actions earlier this week." A measure of foreign demand - the indirect bidder category - accounted for just 12 percent of the sale, the lowest since February 2008.
This could be worrying if it becomes a trend in all maturities since the United States depends heavily on foreign investors, particularly Asian central banks. In the open market, the 30-year bond lost 5 points in price and were last yielding 3.78 percent, a huge jump from Wednesday's close of 3.52 percent. Oddly, the 30-year sale followed a robust reception for an auction of 10-year debt on Wednesday. But on Thursday the 10-year note was suffering along with 30-year bonds. It was last yielding 2.34 percent, jumping from 2.14 at Wednesday's sale.
Investors submitted bids worth 2.08 times the amount of 30-year debt on offer, the lowest since February 2009. Also, investors demanded an extraordinary premium to take down the paper, bidding for a rate 10 basis points higher than the one prevailing in the when-issued market at the auction deadline, according to IFR.
IFR said that was the highest such 'tail' since February 2000. In a sign of how expensive the bond market has become, Treasury's Bureau of Public Debt said the 30-year auction high yield of 3.75 pct was the lowest since March 12, 2009. So even though the bidding was sloppy, the Treasury still got a very low rate for its latest 30-year loan. That may be good news on the ratings front since S&P has said it will watch the interest-rate environment as it evaluates the US credit ratings outlook going forward.
However, that's cold comfort to some fixed income investors wary of low yields. "The Treasury market at these levels had gotten far riskier," said James Kochan, chief fixed-income strategist at Wells Fargo Advantage Funds, with $228 billion in assets under management. "You were taking a substantial amount of risk if you were taking 30-year bonds at these levels." Investment managers took a record chunk of the 10-year US Treasury notes sold on Wednesday, showing voracious appetite for the paper as fears about a of recession and the European debt crisis swirled through markets.