TREASURY AUCTION

Treasuries Gain Prior to Three-Year Note Auction, Fed Meeting Treasuries rose for a second day before a record $37 billion auction of three-year notes and as the Federal Reserve meets to discuss interest rates and its asset purchase program. Ten-year notes gained yesterday for the first time in six days before the first of three debt auctions this week totaling $75 billion, the largest quarterly refunding to date. U.S. stock-index futures declined. The Federal Open Market Committee will keep its key lending rate between zero and 0.25 percent, according to all 45 economists surveyed by Bloomberg. The Fed may also decide whether to extend its $300 billion Treasury purchase plan. “We’ve been able to sustain a bit of a bid today as yields are still attractive,” said Martin Mitchell, head of government-bond trading at the Baltimore unit of Stifel Nicolaus & Co. “There is a general feeling that the refunding will go well, and there are no surprises expected out of the FOMC meeting.” The yield on the 10-year note fell three basis points, or 0.03 percentage point, to 3.75 percent at 9:05 a.m. in New York, according to BGCantor Market Data. The 3.125 percent security maturing in May 2019 rose 7/32, or $2.19 per $1,000 face amount, to 94 31/32. The U.S. government plans to sell $23 billion of 10-year notes tomorrow and $15 billion of 30-year bonds on Aug. 13. President Barack Obama has boosted marketable U.S. debt to a record $6.78 trillion to stimulate the economy and service deficits. Three-Year Notes The three-year notes being sold today yielded 1.84 percent in pre-auction trading. The securities drew a yield of 1.519 percent at the last sale, on July 7, when investors bid for 2.62 times the amount of debt offered, compared with 2.82 at the June auction. Indirect bidders, an investor class includes foreign central banks, bought 54 percent of the notes in July after purchasing 43.8 percent in the prior auction. Ten-year yields surged 37 basis points last week, the most since 2003, as better-than-estimated employment, home-sales and manufacturing data boosted confidence that the U.S. economy is recovering from the worst slump since the Great Depression. Fed policy makers meeting today are likely to discuss the purchases and other quantitative-easing measures, which include buying $1.45 trillion in mortgage-related securities, designed to drag the economy out of the recession. “Policy makers at the FOMC will probably express more optimism about growth and no change to the quantitative easing program,” said Alex Li, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 18 primary dealers that trade with the Fed. The central bank is scheduled to purchase Treasuries due from August 2026 to May 2039 today. It said in March it would buy as much as $300 billion of government securities over six months to cap consumer borrowing costs. Productivity The productivity of U.S. workers grew at an annual 6.4 percent pace in the second quarter, more than forecast, after a 0.3 percent gain in the prior three months, Labor Department data showed today in Washington. The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 1.95 percentage points, from near zero at the end of 2008. The spread has averaged 2.20 percentage points for the past five years. With the Fed on target to complete the planned purchase of $300 billion of Treasuries in September, the exit of this year’s biggest buyer is unlikely to raise yields by depressing prices, the world’s largest bondholders say. Counterproductive The market for TIPS shows traders expect inflation over the next 10 years to average 1.96 percent, which is 0.74 percentage points less than the past decade’s average and too little to erase the value of bonds’ fixed payments. “At this stage it would probably be counterproductive for the Fed to extend this program,” said Mihir Worah, who oversees the $14 billion Real Return Fund for Pacific Investment Management Co. in Newport Beach, California. “The market does not want it to be continued” because an expansion would renew concerns that money printed to fund it would fuel inflation, he said. Treasuries handed investors a loss of 5 percent this year, while U.S. corporate bonds returned 18 percent, according to Merrill Lynch