Treasurys tick up after 2-year auction
Government bonds recover from earlier losses and end the day slightly higher, after the largest sale of 2-year notes in history.
NEW YORK (CNNMoney.com) -- Treasury reversed earlier losses to tick up at the end of the session on Wednesday after the largest auction of 2-year notes in history.
All bonds were down earlier in the day, but then recovered most of their earlier morning losses. At the end of the session, the benchmark 10-year U.S. Treasury bond was up 3/32 at 101 30/32, sending the yield modestly lower to 3.76%, down from 3.77% in the previous day. Bond prices and yields move in opposite directions.
The 30-year longbond rose 3/32 to 101 29/32, and its yield dipped to 4.38% from 4.39% on Tuesday.
Meanwhile, the 2-year note also rose 3/32 to 100 28/32 to send the yield lower to 2.28% from 2.33% earlier in the session.
Record auction: The Treasury Dept. auctioned $32 billion worth of 2-year bond notes Wednesday, the largest auction of 2-year notes in history. A big shot of supply typically sends bond prices lower.
However, after the auction for the 2-year note closed at 1 p.m. EST, the price of the 2-year note was back to where it had started the day.
Anticipation of the auction may have dragged on the price of the 2-year note earlier in the day, said William Larkin, portfolio manager at Cabot Money Management. Once any anxiety over the auction lessened, the market was "going back to the break-even point of the day," he said, since the notes were not auctioned "too far outside the current market price."
"You had a lackluster auction and that is why the price is in line with the market," Larkin said.
Foreign participation in the sale of the 2-year note was low, Larkin noted. "We need foreigners to be buying our debt because we don't have enough internal demand to be buying it," he said.
The record sale of bonds comes as the the stimulus package, among other expenses, has set the government back more than it had expected. The Bush Administration said last month that the deficit is expected to grow to $482 billion in 2009, up from an earlier projection of $407 billion, according to the Office of Management and Budget.
The government is selling debt to cover expenses like the stimulus program and the Iraq war, said Michael Cheah, senior portfolio manager at AIG SunAmerica.
On Thursday, the Treasury department is set to auction $22 billion worth of 5-year notes. The auction for the 5-year note closes at 1 p.m. EST on Thursday.
Durable goods: Orders for big-ticket manufactured goods increased in July, the Commerce Department reported Wednesday morning. Orders for durable goods increased by 1.3%, which far exceeded economists' expectations.
"The durable goods orders came out to be much stronger than expected," said Cheah. "The bond market is now thinking that perhaps the economy is not as weak as it had thought."
Investors typically hide their assets in the safety of government Treasurys when the economy falters, but when the economy appears stronger, investors move their assets to more profitable arenas.
In the morning, bonds were lower in reaction to the durable goods report, because the report showed hope for the struggling economy.
Cheah said that it is important to read the durable goods report with some caution because the number is so volatile.
Oil prices: Oil prices rose to settle above $118 Wednesday as traders worried whether Tropical Storm Gustav might cut crude supplies that come out of the Gulf Coast of Mexico.
Bond traders always watch oil prices closely, but they were paying especially close attention Wednesday to see if Gustav would cause oil prices to spike.
Higher oil prices could potentially "reignite inflationary fears and send bond prices lower," Cheah said.
"On the other hand, there is the opposing school that higher oil prices are a tax on the consumer," Cheah added. "If oil prices would go up, that would mean the consumer would have less money to spend on other items and that would weaken the economy." A weaker economy sends investors running to the safety of Treasurys, sending bond prices higher.
"We will see which school will dominate the market," said Cheah. The two competing pressures also work to cancel each other out, mitigating oil's effect on the bond market.
On Tuesday, bond prices were mixed as Monday's big rally failed to gain traction and investors shrugged off mixed economic data. 
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