Relief for US as bond auction restores calm

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Investors scrambled to buy US government debt at an auction of new Treasury bonds yesterday, helping to assuage fears that the markets are running out of patience with the country's enormous deficits. The US Treasury sold $29bn (£19bn) of seven-year bonds at an interest rate at the bottom end of the day's trading range, despite the continuing shockwaves of a disastrous auction of a similar size a day earlier.

Debt auctions have assumed outsize importance to the mood of the markets, because US politicians have promised to tackle the country's rising national debt but continued to pass legislation that keeps tax rates low and pumps more borrowed money into the economy. At the same time, the Federal Reserve has been battling to keep market interest rates low with its programme of quantitative easing, its promise to purchase $600bn of Treasury debt – but rates have risen, not fallen, since the programme was instituted in November.

Yesterday's better than expected bond auction helped reverse Tuesday's sharp jump in interest rates. In the minutes after the results of the sale were announced, benchmark 10-year Treasury notes were trading higher in price to yield 3.4 per cent, down from 3.49 per cent at the end of the previous day.

The $29bn of seven-year notes were sold at an interest rate of 2.83 per cent, compared with the average forecast of 2.86 per cent in a Bloomberg News survey of dealers.

The results of the sale prompted a private sigh of relief among Treasury officials, rendering Tuesday's auction of $35bn in five-year debt as an aberration. The lack of demand from buyers meant that the price the bonds fetched was lower and, therefore, the interest rate was higher than anyone on Wall Street had expected. US taxpayers will be paying 2.149 per centinterest on the new five-year debt, compared with 2.103 per cent that was the market rate before the auction.

The sale was so poorly received – with a bid-to-cover ratio of 2.61 – that bond investor Bill Gross, co-chief investment officer at fund manager Pimco and known as the "bond king" for his expertise, labelled it "a stinker".

And it triggered a new debate over the extent to which investors will be willing to finance US government debt that has now reached $13.8trillion. The annual budget deficit is $1.3tr and it is not forecast to ever fall below the 3 per cent of GDP level that economists have historically argued is sustainable over the long-term.

Yesterday's return to normalcy suggested that the poor showing of the earlier auction was related more to the thin volume of trading, with market players absent because of the Christmas holiday and snow storms in the north-east.

A bond market sell-off earlier in the month had pushed the interest rate on 10-year debt over 3.5 per cent, frustrating the Fed's efforts to keep rates low. Treasury rates, particularly the rate on the benchmark 10-year bond, are used as the reference point for many other kinds of debt, including mortgage rates.