US Treasury market wilts as Fed waves goodbye

The Federal Reserve's $600 billion Treasury buying spree is over and the bond market is growing nervous now that its biggest bidder has stepped aside.
Barring possible hiccups in August as Congress wrestles with the task of raising the legal borrowing limit, the US government will go on issuing around $166 billion in Treasury bonds and notes a month, and primary dealers aren't quite sure where demand will come from, and at what price.
One possibility lies in investors such as foreign central banks, insurance companies and fund managers, but pulling them in may be tricky; some Treasury yields are near all-time lows. And for the first time since 2005, J. P Morgan is reporting there are no long positions in Treasuries.
Where Europe's sovereign debt troubles once pumped up demand for safe-haven US debt, news that Portugal's debt had been downgraded to junk barely stirred the market this week. Brighter economic data, most recently the ADP National Employment Report, which showed a surprising jump in private- sector employment in June, has further dulled Treasuries' shine at such low yields. Treasuries sold off on Thursday following the ADP number and strong June retail sales.
And Congress is still struggling to raise the debt ceiling, with the latest talks leaving a wide gulf in place between President Barack Obama and Republican lawmakers, as the Treasury's August 2 deadline for a potential default draws near.
For now, primary dealers, the banks and securities firms authorised to bid on behalf of clients in Treasury auctions, will have to wager on a price without the certainty they had of being able to sell the securities quickly in the secondary market, or to the Federal Reserve.
"People are going to be less willing to take on duration without the certainty of three or four buybacks per week to support the market," said Rick Klingman, managing director of Treasury trading at BNP Paribas in New York. Duration is a measure of interest-rate risk.
That has already led to sloppier auctions, with higher borrowing costs for the US government as auction high yields fix at a higher mark than available in the open market, a phenomenon known as a "tail." This happened two weeks ago when three separate auctions "tailed" in the worst week for US government debt sales since March 2010.
Auctions tail when bidders insist on cheaper prices for a given security, or when confusion about the demand for that security causes bidders to behave cautiously. The next test will be next Tuesday when the government sells $32 billion in three-year notes.
"Auctions have been unfolding with participants knowing ahead of time that there would be a buyer in the secondary market post-auction," said Scott Sherman, interest-rate strategist at Credit Suisse in New York, one of the 20 primary dealers.
The Federal Reserve's second round of quantitative easing measures, which began in mid-November and ended June 30, changed the way primary dealers bought and sold Treasuries, presenting a stable - if temporary - way to earn profits from spreads.