By Richard Leong
NEW YORK, June 25 (Reuters) - Bond yields have risen sharply
in the last week, but some traders don't think the selloff is
over as the market prepares for $99 billion in U.S. government
bond auctions over the next three days.
One signal that traders expect higher yields comes from the
key short-term borrowing rate known as the repurchasing rate, or
"repo" rate. This $4 trillion market is key to the daily
operations of Wall Street firms, which borrow cash daily through
repos to finance their trades and operations.
Rates in this market have turned negative, part of the
broader market turbulence stemming from fears of less Federal
Reserve support. Negative repo rates underscore how traders
could borrow a Treasury bond now and repay it later, because
they could buy it back for a lower price if yields rise.
The Fed's announcement last week that it expects to reduce
stimulus later this year if the economy shows further
improvement caused investors to dump stocks, bonds and other
assets, sending global shares tumbling and benchmark U.S. yields
to 22-month highs.
"The sentiment has been very pessimistic. There are not too
many people who are long the market," said Tom Simons, money
market strategist at Jefferies & Co. in New York.
The auction of new government debt comes after the benchmark
10-year Treasury yield on Monday rose to 2.667
percent, highest since early August 2011 and the fastest weekly
jump in a decade last week.
The U.S. Treasury Department will kick off the auctions on
Tuesday with a $35 billion sale of two-year debt, followed by
$35 billion in five-year notes on Wednesday and $29 billion in
seven-year debt on Thursday. Clues to how traders are viewing
these auctions can be seen in repo trading for those maturities.
Normally, Wall Street firms pay an interest rate - the repo
rate - to a bank or a money market fund in exchange for a
short-term cash loan (usually overnight). The dealers offer up
collateral for the loan - normally a Treasury bond.
However, in recent days the market has shifted. There is a
scarcity of Treasury securities right now because Wall Street
dealers and hedge funds have started to short these securities.
When traders short Treasuries, they are betting prices will fall
and yields will rise.
As a result, for a bank or a money fund that needs to invest
its cash to get their hands on a Treasury note, they now have to
accept a lower rate - or in some cases, a negative repo rate.
Thus, the bank or money fund, instead of being paid for lending
out cash overnight, is paying to hold the security.
This has kept the interest rate on repos backed by certain
Treasury maturities negative, or what's known as "special." It
has been particularly acute in the issues that are being
auctioned this week - the two-, five- and seven-year paper.
In Tuesday trading, the overnight rates on repos backed by
two-year notes dipped further into negative territory, last
traded at minus-60 basis points, versus minus-16 basis points on
Monday. Repo rates backed by five-year Treasuries were quoted at
minus 6 to 9 basis points, while repos rates backed by
seven-year notes were quoted at zero to minus 4 basis points.
Some analysts downplayed the negative repo rates, linking
them to this week's Treasuries supply. Bond dealers typically
short Treasuries in the repo market to hedge against coming
"Everyone is positioning themselves, going short into the
auctions due partly to typical hedging ahead of supply," said
Gennadiy Goldberg, interest rate strategist at TD Securities in
Strong demand for these maturities should help stabilize the
bond market here and abroad where yields followed the jump seen
in the Treasuries market, but it is unclear whether investors
will snap up this debt even at these higher yields.
In the "when-issued" market, traders expected two-year notes
that will mature in June 2015 to sell at a yield of 0.4070
percent at 1 p.m. (1700 GMT), which would be the
highest yield at a two-year auction since July 2011. The current
two-year was yielding 0.388 percent.
"We are still kind of bleeding," Goldberg said.