Interest rates surged in the bond market Wednesday after a government debt auction drew only tepid demand for a second day.
The disappointing turnout for the Treasury Department's $42 billion auction of five-year notes raised the prospect that investors' appetite could be waning for Washington's IOUs. If demand for debt drops, the government would be forced to pay higher interest rates to attract investors.
The drop in prices sent yields charging higher. The yield on the five-year note rose to 2.59 percent in late trading from 2.42 percent Tuesday. Its price fell 25/32 to 98 31/32.
The yield also soared on the benchmark 10-year Treasury note maturing in February 2020. That could translate to higher costs for consumers because the 10-year yield is linked to interest rates on mortgages and other consumer loans.
The 10-year yield rose to 3.86 percent from 3.69 percent. The yield had moved between about 3.55 percent to 3.80 percent in the past two months. Its price dropped 1 11/32 to 98 3/32.
A measure of demand at the five-year auction was weaker than it had been earlier in the year. The bid-to-cover ratio came in at 2.55, compared with 2.75 at an auction in February and 2.80 in January.
Most Treasury auctions this year have brought strong demand, and analysts say a few weak auctions doesn't necessarily mean that demand will continue to fall long term. An auction Tuesday of $44 billion in two-year notes also saw demand slip from earlier in the year.
Investors were already cautious ahead of the five-year auction because of Tuesday's results. Prices extended their slide after the government announced the latest results.
David Coard, director of fixed income sales and trading at the Williams Capital Group, L.P. in New York, said investors could be showing their concern about the amount of debt governments are taking on. That includes the so-called sovereign debt of the U.S.
"I always hesitate on the basis of a couple of auctions to think that there is a sea change," he said. "But it could very well be that people are shying away from sovereigns in general."
The government plans to auction $32 billion in seven-year notes on Thursday. That would make the total auctioned for the week a record-tying $118 billion.
Coard said the results of the auction Wednesday raises concerns for Thursday's offering. But he noted that the higher yield of the seven-year note could draw more investors than the lower-paying two and five-year notes have.
The drop in prices and the rise in yields came even as demand for safety increased.
The dollar jumped to its highest level against the euro in 10 months after Fitch Ratings cut Portugal's credit rating. Fitch predicts that a slower economic rebound in the country will make it harder to make good on debt payments. Investors have been watching problems with soaring debt in Europe. Greece has also been struggling to cut its deficit but has managed to avoid a downgrade to its credit rating.
The concern is that debt problems with struggling countries in Europe could have a ripple effect on other markets for sovereign debt, which could threaten the ability of governments to fund economic stimulus measures as many countries remain mired in recession.
In other trading, the yield on the two-year note that matures in March 2012 rose to 1.10 percent from 0.99 percent Tuesday. Its price dropped 4/32 to 99 25/32.
The yield on 30-year bond that matures in February 2040 rose to 4.74 percent from 4.61 percent. Its price fell 1 29/32 to 98 7/32.
The yield on the three-month T-bill that matures June 24 rose to 0.13 percent from 0.12 percent. Its discount rate was 0.14 percent.
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