Despite the recent lows that Treasury yields across the curve have plumbed, primary dealers are expecting Monday's sale of $35 billion in three-year notes to proceed without a hitch and, unless there is a significant rally immediately beforehand, without a tail.
That means that the yield on three-year notes auctioned on Monday will likely match the yield at which comparable securities are trading in the open market. Primary dealers cited the growing consensus that the U.S. economic recovery will be slow and anemic as a driver for demand for three-year notes, even as their yields held at 1.02 percent late on Friday.
If there's no consumer price inflation and funding costs are expected to remain low, and the U.S. economy isn't expected to really come out of this, I don't see why you would oppose that rate, said George Goncalves, head of U.S. rates strategy at Nomura Securities in New York.
Goncalves added that a strong rally Monday morning could derail the three-year auction in the same way that a rally on the morning of the most recent five-year auction in late June caused yields to come in higher than comparable securities were trading at in the market at the same time.
But underlying demand for three-year notes endures, primary dealers said, and foreign interest could be strong. Over the past six auctions, the number of bids for three-year notes has been an average of 3.09 times higher than the number of securities available for purchase. The Treasury department reduced the auction size for Monday's three-year note sale by $1 billion compared to the previous three-year auction, making it likely that the bid-to-cover ratio will remain high.
Central banks have been very active in the three-to-five-year part of the curve, so I think they will be very active on Monday, said Rick Klingman, managing director of Treasury trading at BNP Paribas in New York.
Foreign buyers took down an average of $13.7 billion over the past six auctions, and indirect bidders, a category of bidder often seen as a proxy indicator for foreign central bank demand, bought an average 48.5 percent of the notes auctioned.
A weaker economic outlook spreading throughout financial forecasting firms will also make the three-year note look more appealing.
Everybody's still convinced the Federal Reserve is on hold for quite some time, Klingman said, explaining that the expectation was that the Fed would not raise its target fed funds rate any time soon.
There is a lot of interest in the front end of the curve still, Klingman said.
Monday's auction will be the first of three next week in which the Treasury Department will sell a total of $69 billion of U.S. government debt. It will sell $21 billion of reopened 10-year notes on Tuesday and $13 billion of reopened 30-year bonds on Wednesday.
While Klingman did not expect the three-year yield to rise much before Monday's auction, he said the Treasury market would have to sell off ahead of the second two auctions as longer-dated Treasury yields had reached unattractively low levels.
(Additional reporting by IFR Markets Fixed Income Analyst Courtney Drake; Editing by James Dalgleish)