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With default threat looming, Treasury asks investors to buy $99 billion in new bonds

July 25, 2011 |  8:09 pm

Capitol The U.S. Treasury may not have enough money to pay interest on its debt and other bills come Aug. 2, but it still wants to raise $99 billion selling new bonds over the next three days.

The government will auction $35 billion of two-year notes on Tuesday, $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.

Democrats and Republicans haven’t agreed on a plan to raise the $14.3-trillion debt ceiling ahead of the Aug. 2 deadline set by the Treasury, with the GOP holding out for deeper long-term spending cuts.

Without a higher ceiling by next week’s deadline the Treasury says it risks defaulting on debt payments or other obligations such as Social Security payments.

But this week’s bond sales are likely to get done despite the impasse in Washington -- and despite the risk that the U.S. soon could lose its AAA credit rating. The only question is what kind of interest-rate “concession” investors and Wall Street dealers will demand from the government to soak up the new debt, given the circumstances.

“We may be in for a weak series of auctions,” bond analysts at Nomura Securities said in a note.

Yet the penalty the government might pay may not look like much. Guy Lebas, a bond strategist at brokerage Janney Montgomery Scott in Philadelphia, estimated that the new two-year securities will pay an annualized yield of about 0.44%, up from 0.41% Monday on existing two-year notes.

Why would anyone buy new Treasury securities given the political backdrop? One reason is that many investors still believe default will be averted, although an agreement between Democrats and Republicans may well come down to the wire.

“They may not get a [spending] deal but in all likelihood they’re going to get the debt ceiling raised,” said Kevin Giddis, head of fixed-income investments at brokerage Morgan Keegan in Memphis.

The assumption is that both parties will realize that a U.S. default, even if temporary, could upend global financial markets.

So far, there hasn’t been any sign of panic in the markets over Washington’s stalemate. The Dow  industrial average eased 88.36 points, or 0.7%, to 12,592 on Monday after gaining 1.6% last week.

10yr725 And Treasury bond yields are near their lows for the year. The 10-year T-note yield (charted at right), a benchmark for mortgage rates, edged up to 3.00% on Monday from 2.97% on Friday. But the yield has tumbled from 3.74% in early February.

Treasuries remain in demand because many investors clearly still trust them as a haven, given the slowing global economy, continuing social unrest in the Middle East and Europe’s ongoing government-debt crisis.

Besides, there isn’t another bond market big enough to compete with the liquidity offered by the  Treasury market.

It remains to be seen, though, how investors would react if one or more of the major credit-rating firms were to downgrade the U.S. from its current AAA grade. Standard & Poor’s has warned that it may lower America’s rating if Congress and the White House don’t agree on at least $4 trillion in long-term budget cuts. Moody's Investors Service also has threatened a ratings cut.

In theory, a lower credit rating should push up interest rates on Treasuries, of course. But how’s this for irony: If a downgrade spooks investors, it could drive them to sell supposedly riskier assets -- say, stocks and corporate junk bonds -- and look for somewhere safer to park their cash. That could mean . . . Treasuries.

“It’s counter-intuitive, but a downgrade could cause safe-haven buying of Treasuries,” Giddis said.

-- Tom Petruno


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Photo: The U.S. Capitol. Credit: Getty Images