U.S. two-year auction poised to draw lowest yield in five months

LONDON – Treasury two-year notes set for sale today were poised to draw the lowest yield in five months on speculation the Federal Reserve will keep interest rates low even as it ends its bond-buying program.

The Fed begins a two-day meeting today after saying in September that it would conclude bond purchases, or quantitative easing, this month if the economy keeps improving. The average yields in U.S. Treasuries dropped to the lowest since July 2012 this month amid an increase in demand for haven assets even as U.S. data suggested the country’s growth is accelerating.

“The Fed will probably end its bond purchases this month, but that speculation is unlikely to damp demand for short-dated U.S. notes,” said Richard Kelly, a senior strategist at Toronto-Dominion Bank in London. “The Fed has made it clear the end of QE doesn’t mean rates will have to rise soon, and I suspect they will keep that language. There is no pressing need for them to hike rates.”

The U.S. two-year yield was little changed at 0.39 percent as of 6:53 a.m. New York time. The price of the 0.5 percent security due in September 2016 was 100 7/32.

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The $29 billion of notes being offered today yielded 0.425 percent in pre-auction trading, which would be the lowest level at a sale since May.

The Treasury 10-year yield increased one basis point, or 0.01 percentage point, to 2.28 percent. The average yields of all maturities dropped to 1.28 percent on Oct. 15, the least since July, 2012, according to Bank of America Merrill Lynch Indexes.

Maintain target

U.S. two-year notes are among the securities most sensitive to what the Fed does with its benchmark, the target for overnight lending between banks, which has been in a range of zero to 0.25 percent since December 2008.

Policy makers repeated last month that they plan to maintain the current target for a “considerable time” after asset purchases end, especially if projected inflation continues to run below the central bank’s 2 percent target.

As the Fed concludes its purchases, investors are being left with more long-maturity debt, since the Fed has been buying Treasuries due in four to 30 years.

At the previous two-year sale on Sept. 23, indirect bidders, the class of investors that includes foreign central banks, purchased 40.9 percent of the notes, matching the most since November 2011. The securities were priced to yield 0.589 percent, the highest rate since April 2011.

The auction’s bid-to-cover ratio, which gauges demand by comparing total bids with the amount of debt offered, was 3.56, the most since February at the monthly sales.

Debt sales

The U.S. plans to sell $35 billion of five-year notes tomorrow and $29 billion of seven-year securities the following day. The government will also auction $15 billion of two-year floating-rate debt tomorrow.

Data today will show orders for durable goods in the U.S. rose, gains in home prices slowed and consumer confidence climbed, based on Bloomberg News surveys of economists.

JPMorgan Chase & Co., one of the 22 primary dealers that trade directly with the Fed, is bearish on two-year notes.

Economic growth will be “robust” in the fourth quarter, and market valuations are “rich,” analysts at the company including Jay Barry, Devdeep Sarkar and Bruce Sun, wrote in a report yesterday.

“We recommend staying positioned for higher two-year yields,” the report said.

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