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Weak demand at Treasury note sale fuels another jump in interest rates

February 8, 2011 |  2:06 pm

Investor demand for the government’s sale of $32 billion in three-year notes Tuesday was weak, and that sparked another sharp rise in Treasury bond yields across the board.

The 10-year T-note yield (charted below), a benchmark for mortgage rates, jumped to 3.73%, up from 3.64% on Monday and the highest since last April.

10yrfeb8 That’s going to put more upward pressure on home loan rates.

The Treasury sold the three-year notes at an annualized yield of 1.35%. Just a week ago the market yield on previously issued three-year notes was 1.02%.

After staying in a narrow range since mid-December, Treasury bond interest rates began to surge last week amid a flurry of data showing the economy was strengthening.

That has raised worries about inflation, and about how soon the Federal Reserve might begin to pull back from its easy-money policy.

On Tuesday, Jeffrey Lacker, head of the Fed’s Richmond bank, said policymakers should reevaluate their ongoing purchases of Treasury bonds -- a program launched in November and aimed at pumping more money into the economy.

"The distinct improvement in the economic outlook since the program was initiated suggests taking that reevaluation quite seriously," Lacker said at a business meeting.

He’s at odds with Fed Chairman Ben S. Bernanke, who insisted last week that the central bank wasn’t ready to begin tightening credit, a view he's expected to reiterate in testimony before a House panel on Wednesday.

Yet investors continue to demand higher yields to buy bonds.

The three-year-note auction showed that many investors remain on the sidelines or are shifting money into other assets -- such as stocks. The Dow Jones industrial average rose 71 points, or 0.6%, to a new 2 1/2-year high of 12,233.15 on Tuesday, amid another broad rally.

One sign of the lack of demand at the three-year T-note sale: Wall Street dealers ended up buying 62% of the notes, much more than usual, said Ian Lyngen, a partner at bond trader CRT Capital Group in Stamford, Conn. The government expects dealers to step up as buyers when necessary.

The Treasury’s data on the sale indicated that foreign investors “didn’t show up in any major form” at the auction, Lyngen said.

The government will be back in the market Wednesday, auctioning $24 billion in 10-year notes. On Thursday it will sell $16 billion of 30-year bonds.

-- Tom Petruno