Treasury Supply Weighs on Dollar Sentiment

The US Treasury sells $78 bln in notes and bonds this week and $60 bln in bills. The continued deluge of supply weighs on dollar sentiment, especially given indications from the G7 that the pain threshold to stop the dollar's decline has not been reached. The auctions begin with $7 bln 10-year inflation protected security and the bills today, followed by a record $39 bln three-year auction tomorrow, re-opened 10-year auction Wed for $20 bln and re-opened 30-year bond sales trying to raise $12 bln on Thursday.

Demand, foreign and domestic, is expected to be stronger for the short-end of the curve. The 2- and 3-year notes have generated a slight positive return thus far this year (roughly 1.14%, according to industry indices), while the 5-year has recorded a small loss (-0.37%), while the 10-year and 30-year bonds have seen steeper losses (-5.7% and -18.6% respectively).

The Federal Reserve has nearly completed its $300 bln Treasury purchases, having bought about $293 bln through the middle of last week. The US Treasury has sold about $1.52 trillion of notes and bonds thus far this year, not quite 3-times the $585 bln sold in the same year ago period. The Federal Reserve continues with its purchases of mortgage backed securities. These purchases, coupled with unwinding of the T-bills that the Treasury previously provided to finance some of the Fed's purchases, and the already unwinding of several of the Fed's liquidity facilities is expected to translate into an expected jump in both the Fed's balance sheet and bank reserves in the coming period.

The fact that the Fed is still engaged in what it calls "credit easing" seems to make any coordinated intervention in the foreign exchange market highly unlikely. If intervention is best envisioned as an escalation ladder, officials are confined to only the low rungs, expressed as concern largely couched in terms of volatility, by the US policy thrust. The Fed's purchases of mortgage backed securities will be complete by the end of Q1 10 and that may cast the next G7/G20 meetings in a different light.