Central Banks can't get enough of US Treasuries - the largest bubble in the history of financial times, even surpassing the tulip craze.

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Treasuries Rise as Dollar Weakness Spurs 3-Year Note Demand

Nov. 9 (Bloomberg) -- Treasuries rose as the drop in the dollar to a 15-month low spurred the strongest demand on record from a group of investors that includes foreign central banks at today’s $40 billion sale of three-year notes.

Indirect bidders purchased 68.5 percent of the record auction of the securities. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.33, the most since at least 1993. The average at the last 10 auctions was 2.63.

“In a weird way, a weaker dollar helps the Treasury auctions,” said Carl Lantz, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 18 primary dealers required to bid at Treasury auctions. “Some foreign institutions feel obliged to buy even more dollars to support the dollar against their own currency because they don’t want their own currencies to appreciate too much.”

The 10-year note yield fell three basis points, or 0.03 percentage point, to 3.47 percent at 1:36 p.m. in New York, according to BGCantor Market Data. The 3.625 percent security maturing in August 2019 rose 7/32, or $2.19 per $1,000 face amount, to 101 9/32.

The three-year notes sold today drew a yield of 1.404 percent, below than the forecast of 1.419 percent in a Bloomberg News survey of nine of the Federal Reserve’s primary dealers. The yield on the current three-year note fell one basis point to 1.36 percent.

‘All Boats Rise’

“We are witnessing, month after month, stronger and stronger auctions as if there is not enough supply to go around and it’s a very telling market that when you have so much liquidity flowing through, all boats rise,” said George Goncalves, chief fixed-income rates strategist at primary dealer Cantor Fitzgerald LP. “The bond market, stock market, commodity market, anything that has a price tag is going up in value.”

The last auction of three-year notes, a then-record $39 billion offering on Oct. 6, drew a yield of 1.445 percent, which was the lowest since April. The bid-to-cover ratio was 2.76.

Indirect bidders bought 49.1 percent of the notes offered at the October sale. The Treasury began selling debt maturing in three years in November 2008 after an 18-month hiatus.

The Treasury is scheduled to sell $25 billion of 10-year debt tomorrow and $16 billion of 30-year bonds on Nov. 12. Both are records.

Budget Deficit

“These auctions should go well because foreign demand remains strong and the market needs the bonds,” Kevin Giddis, head of fixed-income sales, trading and research at brokerage firm Morgan Keegan Inc. in Memphis, Tennessee, wrote in a note to clients. “If there is a struggle, it will likely happen with the 10-year auction as investors may balk at the returns versus the maturity risk.”

The U.S. budget deficit widened to a record $1.42 trillion in the 12 months to Sept. 30 as President Barack Obama increased spending to revive the economy.

The U.S. House approved health-care legislation that would cost more than $1 trillion over 10 years, indicating the government will have to increase its debt sales to pay for it.

“We are kind of caught between record supply and the new health-care bill passing that passed in the House,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Capital Markets LLC, a New-York based brokerage for institutional investors. “If it gets passed in the Senate it will raise taxes on consumers and corporations, which is not good for the economy and adds to the weakness in the dollar. At the end of the day the lower dollar does bring in demand for auctions this week.”

‘Double Whammy’

Japanese investors who lived through a decade of deflation and recessions say U.S. Treasuries are a bargain. Deflation, a general decline in prices, enhances the value of a bond’s fixed payments.

Japan bought a net $105 billion of U.S. government debt through August, exceeding China as the biggest foreign buyer and boosting its holdings to $731 billion, or more than 10 percent of the total market, Treasury Department data show. The 17 percent increase is the most since a 25 percent surge in 2004.

Mizuho Asset Management Co. and Mitsubishi UFJ Asset Management Co. are among the investors buying U.S. bonds because they see similarities between America’s response to the recession and their government’s efforts during the so-called lost decade of the 1990s.

“The U.S. economy has faced a double whammy: the recession and credit contraction,” said Akira Takei, head of non-yen denominated bonds at Mizuho Asset in Tokyo, a unit of Japan’s second-largest bank. “The U.S. will face a triple whammy with deflation. That’s good for the Treasury market.”

Yields indicate inflation expectations are increasing. The difference between rates on U.S. 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 2.23 percentage points from about zero at the end of last year.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net.

Last Updated: November 9, 2009 13:41 EST