Demand for ‘Inflation-Proof’ Notes Sinks at 2nd Auction
The Treasury’s second sale of inflation-indexed notes drew far less demand than the inaugural sale in January, forcing the government to pay a higher-than-expected yield on the securities.
The Treasury sold $8.003 billion of the notes Tuesday at a yield of 3.650%, up from 3.449% in January.
The notes will mature in 9 3/4 years and will track, with a three-month lag, increases in the consumer price index as calculated by the Labor Department. The inflation adjustments will be added to the principal of the notes and will be payable at maturity.
“This one was taken up by longer-term investors,” said Dan Bernstein, head of research at Bridgewater Associates Inc., a Wilton, Conn., firm whose $5.5 billion in managed assets includes indexed bonds.
Federal Reserve Board Chairman Alan Greenspan may also have played a role in the low demand at the auction by recently prodding his fellow central bankers to raise the interest rate on overnight bank loans to slow the economy.
“The Fed has shown it will be aggressive as an inflation fighter,” said Astrid Adolfson, an economist at New York-based MCM MoneyWatch. “In that case, you don’t have to be as worried about inflation--especially when it’s been so benign.”
Still, Treasury officials remain upbeat. Tuesday’s auction “was a success. January would be hard to match,” said a senior official, who spoke on the condition that he not be identified by name. The Treasury is committed to building “steady growth in the market,” he said.
At the first auction Jan. 29, the Treasury sold $7.003 billion in 10-year notes. The yield of 3.449% was lower than expected as demand for the notes exceeded supply by more than 5 to 1--more than double the demand of a typical sale.
In contrast, the bid-to-cover ratio at Tuesday’s auction, which gauges demand by comparing bids with securities sold, was only 2.26.
The Treasury said purchases by individuals through the Treasury Direct program fell to about $7 million Tuesday from $28 million in the first auction.
Another reason for the higher-than-expected yield could be a concern among investors that an experimental consumer price index to be unveiled Thursday by the government may eventually result in a lower reported inflation rate, and lower payouts to holders of the notes over their 10-year life.
The new index--christened CPI-U-XG--will calculate the price of goods to account for the so-called substitution effect: people’s tendency to switch to cheaper versions when the price of a product rises.
The new index will produce smaller price increases and possibly understate the cost of living, because the Bureau of Labor Statistics will assume that when the price of a good rises, Americans consume less of that good.
The government is only testing the formula, but if it’s formally adopted, “the markets for inflation-linked securities could be directly affected,” according to a report by economist William Kenn at Merrill Lynch & Co. in New York.
Tuesday’s offering, though $1 billion more than the first auction, is only a fraction of the government’s more than $3 trillion in tradable debt. The Treasury will continue to sell its standard 10-year notes six times a year.
