Consider the facts. The Treasury announces to the entire galaxy that its selling $9 billion in 30-year bonds. They get a yield of 4.449%. According to Bloomberg News, the pre-auction trading had indicated the yield would be 4.41%, indicating the actual results were a 4bps miss. Did the auction go poorly? It sure did. Not only was it a 4bps miss in yield, but 89% of it was purchased by dealer firms, which indicates that actual end buyers only stepped up for 11% of the sale.
But what happened next can't fully be explained by those auction results. The 30-year continued to sell off, rising another 10bps in yield to 4.558, or -1.6% in price, over the next hour. It strains logic to say that the Treasury holds an auction, the price is somewhat disappointing, so therefore the price should be an additional 1.6% lower.
Further consider that the 3 1/2 point drop in the 30-year was the largest single day move since April 2004. So what happened in April '04? That was the day that the Labor Department reported that the economy added 334,000 jobs in March of 2004, after only having added 27,000 in February. That data point convinced the market that the Fed was ready to hike rates, then at 1%, which indeed it did that June.
Contrasting the significance of that event with yesterday's auction result, and it becomes more apparent that something more is afoot.
Perhaps the rumor that the ISM services index was miscalculated? Released on Tuesday at a recessionary reading of 41.9, the figure spurned a 370-point plunge in the Dow. The specific rumor of a data error was debunked, but Greg Ip reported on the Wall Street Journal's website that other measures of the service sector don't look as dire. Perhaps this means there was no calculation error per se, but still the released figure was understated for some other reason, which will later come out in revisions.
The ISM story fits a 3 1/2 point sell-off better than a weak auction. Treasury yields at current levels can only be supported if the Fed holds interest rates low for an extended period of time and inflation doesn't become a problem. Traders know this is a very fine line to walk, and confidence in Bernanke's ability to walk that line is, well, not as strong as it could be. It will probably take a pretty stiff recession to keep inflation low despite highly accomodative monetary policy. Tuesday's ISM report supported the idea that we are already in a recession, and therefore supported rates at their current levels. But if it turns out we aren't in a recession, the Fed will have to make a rapid reversal of policy to combat inflation. If so, long rates will be the big loser.
Now I still think the Fed is headed back to 1%. I might be wrong, but until that happens, I'm happy to own duration in the middle of the curve.
But the long bond becomes a question of risk/reward. The 30-year Treasury is within 30bps of its all-time low in yield. So if it is a drawn out period of easy money, and somehow we avoid inflation, that's probably your upside. But if either inflation becomes a problem or the economy is stronger than we think, your downside is much larger.